The Dollar's Inevitable Demise

Consider these figures. The current size of the American economy is roughly $14 trillion. As of this writing, the federal government's total public debt stands at nearly $13 trillion.

In its first midsession review, the White House Office of Management and Budget estimated that at the end of 2010, the national debt will breach the $14-trillion mark. This means that America's sovereign debt will be soon equal to the annual output of our economy. In other words, our national debt will shortly reach 100 percent of GDP. History and experience show that most governments that assume such levels of debt are ultimately not able to contain them. In most cases, this kind of situation eventually leads to the disintegration of the country's monetary regime and the collapse of its currency.

This outcome is not inevitable, given that -- in theory, at least -- a debt of 100 percent of GDP is still manageable. But to bring things under control would require strict fiscal discipline. Unfortunately, there no indication that our federal government can muster any. Quite the contrary. Last year the federal budget deficit reached a record $1.4 trillion. At nearly 10 percent of GDP, this was the highest peacetime deficit in history. Despite the numerous assurances that the 2009 shortfall was a one-off event brought on by the financial crisis, this year's deficit will go even higher. According to the analysis submitted by the Congressional Budget Office last month, it will climb to $1.5 trillion. This will amount to 10.3 percent of GDP.

There is every reason to believe that the deficit will grow even faster in the years to come, as the federal government further increases its involvement in health care. The estimates by the Office of the Management and Budget which we quoted above do not factor in the costs associated with the recently passed health care reform. Even the more conservative estimates project that the legislation will cost well over one trillion during the program's first ten years. It is almost certain, however, that this figure is grossly understated, as government programs have a tendency to exceed their initial cost projections by grotesque multiples.

This, however, is not the worst of it, because the national debt represents only a relatively small portion of our government's total financial obligations. The far greater bulk is made up of long-term liabilities inherent in entitlement programs. According to the latest estimates by the Dallas Federal Reserve, the combined liabilities of Medicare, Social Security, and Medicaid amount to an astounding $104 trillion.

When we add the national debt and entitlements together, we get a figure of some $117 trillion. This figure represents the amount of money the federal government will have to come up with in the years ahead in order to discharge its obligations.

The sheer magnitude of this number makes it difficult to grasp. To give a sense of scale, it is about twice the current economic output of the whole world. It is also more than eight times the size of the American economy. With today's tax revenues it would take more than fifty-five years to pay for these obligations. This assumes there is no interest on the debt and that the federal government spends no money on anything else.

There is only one conclusion that reasonably can be  drawn on the basis of these figures: The American federal government is simply not in the position to make good on its obligations.

There is a growing recognition of this fact. When discussing America's national debt in his lecture at the Mises Institute, the noted financial analyst Peter Schiff said this:

We're not going to pay the Chinese back their money. It's impossible. We can't. We can't possibly.

Given the figures, Schiff only stated the obvious.

Sooner or later, our government's ability to finance deficit spending with low yield bonds will come to an end. Deprived of the source of cheap cash and pressed by the need to meet its vast array payments, the government will be left with two options: It will either have to default, or it can seek to meet the payment schedules by creating new money.

Given the dollar's status as the world's reserve currency, default would be a cataclysmic global event that would result in the disintegration of the world's financial system. Needless to say, this kind of calamity would bring about the dollar's sudden collapse with ruinous consequences for the American people.

The second option -- paying its outstanding bills with new money -- looks initially more attractive. On this scenario government would discharge its liabilities with freshly created dollars. This is actually the most likely course our government will take, since money creation is the route that over-leveraged governments usually take in an effort to service their excessive obligations.

At first sight this may seem like an easy way out, but it has bad consequences down the line. As the government pumps new dollars into the system, the value of the money stock is diluted and inflation occurs. In light of the enormous depth of our indebtedness, inflation will in the end eat away most of the dollar's value.

It should be noted that inflation is really only default in disguise. On the inflationary scenario, creditors will only get paid back a portion of their original investment while entitlement beneficiaries will only receive a portion of the value of their promised benefits.

Whichever of the two possible options our government chooses to pursue, the final result will be currency destruction. Outright default would result in the dollar's immediate collapse, while inflation would produce a more gradual decline, at least initially. Needless to say, given the immense weight of the government' financial burden, the inflationary route will ultimately wipe out most of the greenback's worth. Either way, we will end up with a greatly debased, if not completely worthless, currency and all the painful repercussions inherent in that downfall.

To put it bluntly, the dollar's days are numbered and its demise is inevitable. Anyone who still hopes there may be a way around it, must answer that ultimate money question: Where in the world is the American federal government going to get $117 trillion?

Any suggestions?
Consider these figures. The current size of the American economy is roughly $14 trillion. As of this writing, the federal government's total public debt stands at nearly $13 trillion.

In its first midsession review, the White House Office of Management and Budget estimated that at the end of 2010, the national debt will breach the $14-trillion mark. This means that America's sovereign debt will be soon equal to the annual output of our economy. In other words, our national debt will shortly reach 100 percent of GDP. History and experience show that most governments that assume such levels of debt are ultimately not able to contain them. In most cases, this kind of situation eventually leads to the disintegration of the country's monetary regime and the collapse of its currency.

This outcome is not inevitable, given that -- in theory, at least -- a debt of 100 percent of GDP is still manageable. But to bring things under control would require strict fiscal discipline. Unfortunately, there no indication that our federal government can muster any. Quite the contrary. Last year the federal budget deficit reached a record $1.4 trillion. At nearly 10 percent of GDP, this was the highest peacetime deficit in history. Despite the numerous assurances that the 2009 shortfall was a one-off event brought on by the financial crisis, this year's deficit will go even higher. According to the analysis submitted by the Congressional Budget Office last month, it will climb to $1.5 trillion. This will amount to 10.3 percent of GDP.

There is every reason to believe that the deficit will grow even faster in the years to come, as the federal government further increases its involvement in health care. The estimates by the Office of the Management and Budget which we quoted above do not factor in the costs associated with the recently passed health care reform. Even the more conservative estimates project that the legislation will cost well over one trillion during the program's first ten years. It is almost certain, however, that this figure is grossly understated, as government programs have a tendency to exceed their initial cost projections by grotesque multiples.

This, however, is not the worst of it, because the national debt represents only a relatively small portion of our government's total financial obligations. The far greater bulk is made up of long-term liabilities inherent in entitlement programs. According to the latest estimates by the Dallas Federal Reserve, the combined liabilities of Medicare, Social Security, and Medicaid amount to an astounding $104 trillion.

When we add the national debt and entitlements together, we get a figure of some $117 trillion. This figure represents the amount of money the federal government will have to come up with in the years ahead in order to discharge its obligations.

The sheer magnitude of this number makes it difficult to grasp. To give a sense of scale, it is about twice the current economic output of the whole world. It is also more than eight times the size of the American economy. With today's tax revenues it would take more than fifty-five years to pay for these obligations. This assumes there is no interest on the debt and that the federal government spends no money on anything else.

There is only one conclusion that reasonably can be  drawn on the basis of these figures: The American federal government is simply not in the position to make good on its obligations.

There is a growing recognition of this fact. When discussing America's national debt in his lecture at the Mises Institute, the noted financial analyst Peter Schiff said this:

We're not going to pay the Chinese back their money. It's impossible. We can't. We can't possibly.

Given the figures, Schiff only stated the obvious.

Sooner or later, our government's ability to finance deficit spending with low yield bonds will come to an end. Deprived of the source of cheap cash and pressed by the need to meet its vast array payments, the government will be left with two options: It will either have to default, or it can seek to meet the payment schedules by creating new money.

Given the dollar's status as the world's reserve currency, default would be a cataclysmic global event that would result in the disintegration of the world's financial system. Needless to say, this kind of calamity would bring about the dollar's sudden collapse with ruinous consequences for the American people.

The second option -- paying its outstanding bills with new money -- looks initially more attractive. On this scenario government would discharge its liabilities with freshly created dollars. This is actually the most likely course our government will take, since money creation is the route that over-leveraged governments usually take in an effort to service their excessive obligations.

At first sight this may seem like an easy way out, but it has bad consequences down the line. As the government pumps new dollars into the system, the value of the money stock is diluted and inflation occurs. In light of the enormous depth of our indebtedness, inflation will in the end eat away most of the dollar's value.

It should be noted that inflation is really only default in disguise. On the inflationary scenario, creditors will only get paid back a portion of their original investment while entitlement beneficiaries will only receive a portion of the value of their promised benefits.

Whichever of the two possible options our government chooses to pursue, the final result will be currency destruction. Outright default would result in the dollar's immediate collapse, while inflation would produce a more gradual decline, at least initially. Needless to say, given the immense weight of the government' financial burden, the inflationary route will ultimately wipe out most of the greenback's worth. Either way, we will end up with a greatly debased, if not completely worthless, currency and all the painful repercussions inherent in that downfall.

To put it bluntly, the dollar's days are numbered and its demise is inevitable. Anyone who still hopes there may be a way around it, must answer that ultimate money question: Where in the world is the American federal government going to get $117 trillion?

Any suggestions?