Fearing the U.S. dollar

Recently, I went to a meeting of high-net-worth investors in Belize. An old friend of mine, a successful international asset-protection lawyer, organized the meeting. The attendees were almost all Americans and mostly near or past retirement age. For the first time in my career, when I began talking about the huge fiscal problems facing America and the U.S. government, there was widespread recognition by the audience of the facts and the figures I was presenting.

Admittedly, this was a pretty sophisticated audience, but it still was a first.

But not everyone was worried. One younger attendee, the CEO of an interesting start-up company in Southern California, said: “I remember people talking about these same problems in the early 1990s, but then, like a year or two later, the government was actually running a surplus. There wasn’t really a problem at all. So what’s different now?”

When it comes to the level of U.S. government debt, I hope all of my readers pay attention to one key statistic: the amount of the government’s revenues that must go toward paying interest. As everyone who has ever paid a mortgage knows, carrying debts can become prohibitively expensive. My concern is the U.S. already has more debt than it can afford, which puts it at an enormous risk of a debt and currency collapse. While I wish I would be wrong, I’ve learned that when it comes to finance, the numbers rarely lie.

Here’s what I told the audience in Belize: the big problem we face right now is the Treasury has moved more than half of our total debt into the very short end of the yield curve. It did this to minimize interest expense. But as a result, we’ll have to “roll over” roughly $4 trillion in the next 30 months. That’s in addition to funding another $3 trillion or so in additional annual deficits. It’s an interesting question, whether or not we can actually do this. We cannot do it if China stops buying massive quantities of Treasury bonds.

And as of March 29, China was a net seller of Treasury debt. If we can’t fund our debts in the bond market, the Federal Reserve will be forced to monetize our deficits by buying Treasury bonds. If that happens, inflation will soar and the price of gold will double or triple almost overnight.

The bigger problem, over the long term, is simply debt service. Right now, the federal government takes in roughly $1 trillion in income taxes and a much smaller amount of money in other fees, duties, etc. (The government takes in another $1 trillion from Social Security and Medicare taxes, but it spends more currently on these programs than it takes in. So as a result, this revenue can’t factor into our analysis of debt service.) At the end of 2009, the federal government had $11.8 trillion in total outstanding debt. That’s the official number.

Likewise, officially, the interest we paid last year made up 11 percent of the government’s revenues – but that measure included all of the social-insurance premiums as tax. More importantly, the current budget doesn’t include a number of highly significant obligations that are actually the government’s responsibility, but are held “off balance sheet.”

Here’s a small list of the government’s off-balance-sheet obligations:

1. All of the government-sponsored-entity debt. Fannie Mae and Freddie Mac are now completely controlled and majority-owned by the U.S. government. Combined, they owe more than $1.6 trillion. This doesn’t include any of their mortgage guarantees, which could easily end up costing another $500 billion.
2. The looming FDIC shortfall. The U.S. now has more than 700 insolvent banks (at least). Assets of these banks total more than $400 billion. The FDIC has a negative balance of $20 billion. The FDIC is legally required to keep a reserve ratio. Thus, by the end of this year, the FDIC will need to borrow hundreds of billions of dollars. My estimate is $500 billion in funding by the end of 2011.
3. Federal Housing Administration guarantees. Although you won’t find these obligations on any federal ledger, the FHA – the wholly owned mortgage-finance arm of the federal government – now has insured roughly $800 billion in subprime mortgages. Most of these loans required only a 3.5-percent down payment. And nearly half of the loans were originated after 2008. These loans will end up having the highest default rates of any loan pool. I estimate losses of near $500 billion.

Please keep in mind, these obligations aren’t future promises to pay. This isn’t Medicare spending projected out until 2040. These are all obligations that either have known maturities or will come due in the next two or three years. There isn’t much guessing about the magnitude of any of these obligations.

Thus, by the end of Obama’s first presidency (2013), I believe the U.S. will owe roughly: $17.8 trillion in federal debt, $2 trillion in government-sponsored-entity debt/guarantees, $500 billion in FDIC obligations, and $500 billion in FHA obligations. My only big assumption is $1.5 trillion in additional deficits each year, which is what the president’s budget also predicts.

What’s a reasonable rate of interest on these debts? Right now, it costs the U.S. government almost 5 percent to borrow for 30 years. Let’s assume the blended borrowing cost goes to that amount – which is well below the government’s average borrowing costs since 1980. That would equal $1 trillion in interest payments due, per year. That’s 100 percent of all income taxes paid in 2009.

I hope I don’t have to explain to you why this amount of debt isn’t sustainable. I’m not the only person in the world who can do basic math and has access to the government’s accounts. Says Felix Zulauf, one of Europe’s top money managers, “Eventually the U.S. will arrive at the point where, as Marc Faber says, interest payments on government debt all of a sudden go to 20 percent, 25 percent, 30 percent of tax revenue. And once you go above 30 percent, you are done. You go into default or your currency breaks down and your system collapses.”

Or perhaps you will recognize this name: Alan Greenspan. He says there has always been “a large buffer between the level of our federal debt and our capacity to borrow,” but that’s disappearing now. “I’m finding it very difficult to look into the future and not worry about that.”

Obviously, I can’t know for certain what will happen to the U.S. dollar over the next three years. It is certainly possible for our economy to grow fast enough to support our soaring federal debt. The problem is, that’s unlikely. Meanwhile, the growth of our debt and interest expenses is a mathematical certainty.

No one else is going to give you a warning this stern. They’re afraid they’ll be wrong and end up being embarrassed. I’m not worried about that. I’d love to be wrong. I would much prefer to be embarrassed than to see my country’s economic power destroyed and millions of people wiped out financially.

So, just look at the numbers. If I’m wrong about any of them, let me know. Otherwise, please … act now to protect yourself. If you wait until the last minute to get your assets out of the U.S., you’ll never make it.