Brazil Is the New America: How Brazil Offers Upward Mobility in a Collapsing World (28 page)

7
“Historical Debt Outstanding—Annual 2000–2010,” TreasuryDirect,
www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm
.

8
Calculated as 13.56 − 5.807 = 7.753; 7.753 ÷ 5.807 = 133%

9
Laurence Kotlikoff, “U.S. Is Bankrupt and We Don't Even Know It,” Bloomberg News, August 10, 2010,
www.bloomberg.com/news/2010-08-11/u-s-is-bankrupt-and-we-don-t-even-know-commentary-by-laurence-kotlikoff.html
.

10
Bruce Bartlett, “How Excessive Government Killed Ancient Rome,”
Cato Journal
14, no. 2 (Fall 1994).

11
Peter Garnsey, Dominic Rathbone, and Alan K. Bowman, eds.,
The Cambridge Ancient History, Vol. XI: The High Empire, A.D. 70–192
(Cambridge, UK: Cambridge University Press, 2000).

12
Martin Vaughan, “Increasing Number of U.S. Expats Give Up Citizenship as IRS Gets Aggressive about Overseas Asset Reporting,” Cuenca High Life, April 7, 2010,
www.cuencahighlife.com/post/2010/04/07/Increasing-number-of-US-expats-give-up-citizenship-as-IRS-gets-aggressive-with-overseas-bank-accounts.aspx
.

13
“Nearly Half of US Households Escape Fed Income Tax,”
CNBC.com
, April 8, 2010,
www.cnbc.com/id/36241249/Nearly_Half_of_US_Households_Escape_Fed_Income_Tax
.

14
Bill Bonner, “Subprime State of Mind,”
The Daily Reckoning
, April 19, 2012,
http://dailyreckoning.com/subprime-state-of-mind
.

15
Lynn Harry Nelson, “The Later Roman Empire,” WWW Virtual Library,
www.vlib.us/medieval/lectures/late_roman_empire.html
.

16
The Association of Americans Resident Overseas,
www.aaro.org
.

17
Steven A. Camarota and Karen Zeigler, “Homeward Bound: Recent Immigration Enforcement and the Decline in the Illegal Alien Population,” Center for Immigration Studies, July 2008,
www.cis.org/trends_and_enforcement
.

18
John C. Fredenberger, “Tell the IRS What You Think of Their New Financial Report Form!,” Association of Americans Resident Overseas,
http://aaro.org/component/content/article/50-fyi-taxation/296-tell-the-irs
.

19
Joe Hicks and Grahame Allen, “A Century of Change: Trends in UK Statistics since 1900,” A House of Commons research paper,
www.parliament.uk/documents/commons/lib/research/rp99/rp99-111.pdf
.

None of the Brazilian banks has come under the suspicion of being weak. The balance sheets are very strong. The Brazilian corporate sector is extremely underleveraged. The Brazilian citizen is underleveraged. The credit to [gross domestic product] ratio in Brazil is just above 30 percent. It used to be in the low 20 percent range, and 30 percent is still quite a low figure. Despite all that, what we're witnessing with European and American banks has made everybody more cautious and has brought [the credit markets] to a halt here.

—Candido Bracher, Chairman, Banco Itau, December 18, 2008

It is a cliché—indeed, an article of faith—among most Americans that the United States is the richest country in the world. But, alas, this is no longer true. Unfortunately, most of us appear to have missed an important bulletin that dates back to 1494—two years after Columbus discovered America. That's when the Tuscan friar Luca Bartolomes Pacioli surprised the world with his
Summa de Arithmetica
, the first book in print to explain the mysteries of double entry bookkeeping.

Fra. Pacioli's work sparked a realization that in order to accurately appraise your wealth it is not enough to just add up your assets. You must also subtract your liabilities. Hence the bad news for those who still believe that the United States is the richest country in the world.

I am reminded of a charming story told about Donald Trump during the downturn of the early 1990s, when his leveraged real estate empire had come to grief with the banks. One night, Trump was walking in the Upper East Side of Manhattan with his beautiful girlfriend when they encountered a vagrant. Trump surprised his girlfriend by saying that the homeless man was worth a billion dollars more than he was. She said, “But he doesn't look like he has a penny.”

“He doesn't,” Trump replied.
1

Equally, while the U.S. standard of living remains high by any reasonable standard of accounting, the United States is one of the poorer countries in the world—if not the poorest. After a multidecade borrowing binge, we owe over $14 trillion to the rest of the world. The national debt is just the tip of the iceberg, the portion of our overseas borrowings that has been converted into U.S. Treasury securities.

We used to beguile ourselves that it didn't matter how high the debt grew because “we owe it to ourselves.” Not so much. According to the Treasury statistics, (current as of August 2011) the U.S. government owes approximately $865 apiece to each and every citizen of China and $1,034 to each Brazilian. Other vast sums are owed just about everywhere. We should have known better. And so should the Chinese, the Brazilians, and the others.

The United States government not only sports a national debt exceeding 100 percent of GDP, but has also created unfunded liabilities in astronomical sums, likely exceeding the total value of world output. As mentioned, Professor Laurence Kotlikoff puts the sum at $202 trillion by citing congressional figures.
2
More conservative, or perhaps less comprehensive, estimates of U.S. unfunded liabilities range as low as
USA Today
's $62 trillion
3
—a “low” guess which is barely below
The Economist'
s estimate of world GDP at $65 trillion in the 12 months to May 2011.
4

When state and local government debt are added, the total U.S. debt picture is so ugly that it would make young children cry—if they had any inkling what it implies for their future. But it is rather much to expect the kids to be bawling as if they understood accounting better than their parents and grandparents when even hedge fund and money managers seem to have been hoaxed by the fairyland accounting U.S. banks use to pad their earnings.

As reported in the
Financial Times
, 80 percent of the $16 billion in quarterly net profits (almost $13 billion) recently reported by big U.S. banks, including Citigroup, Bank of America, J.P. Morgan, and Goldman Sachs, came from the banks claiming that the fall in the value of their own debt was income. Sounds crazy doesn't it? But that's what happened.

The banks claimed that their creditworthiness had fallen, enabling them to write down the value of what they owe to reflect the greater risk that they will not pay it all back. They then claimed the difference as income.

These are hints to the wise: the insolvency of the U.S. government and the U.S. banking system should not go unnoticed. They tell you that life has changed. The rules of the world you grew up in are different. A major phase of economic history is coming to an end.

The age of American prosperity is over. I say that deliberately. The average American races on a hopeless treadmill where he or she must go faster and faster to stay in the same place. What to make of it? My sometime friend, Bill Clinton, warns: “People have been betting against America for 200 years and they all wound up losing money.”
5
As a description of the past, Bill Clinton's observation is accurate. But I don't recommend that you pay him for investment advice; I doubt it will hold true in the future.

It is not just the government whose liabilities are cascading while its assets fall. The typical American's home has doubled in size since 1970. But a big house doesn't mean Americans are any wealthier. Those new McMansions have plunged in value, causing Americans to lose an aggregate of $7 trillion.

Even though our assets have shriveled, the net liabilities of Americans have grown.

Notwithstanding hopeful hype about recovery, mainly driven by unsustainable monetary and fiscal stimulus, the U.S. economy is headed for a wrenching adjustment that will push living standards down over a period of many years or even decades. I expect to see half a century's worth of economic progress wiped away.

This is not really so bold a statement as it may appear. From the perspective of the average American, there has been precious little progress over the past four decades. The average American male with full-time employment has lost $800 in annual purchasing power over this period.

Living standards seemed to continue rising, albeit erratically, principally for two reasons:

As the
Economist
reported in “Deleveraging: You Ain't Seen Nothing Yet,” a study by the McKinsey Global Institute

noted that combined public and private debt burdens had reached historic highs in many rich countries. Based on previous episodes of debt reduction, it reckoned that once deleveraging began, countries would on average spend the next six to seven years whittling those debt ratios back by around 25 percent.
6

This implies slower growth for the United States, culminating in a sovereign credit crisis, probably before 2015. Already, the U.S. fiscal ratios are worse than those of Portugal, which entered a solvency crisis with sovereign debt totaling 93.3 percent of GDP. And the U.S. ratios are worse still than those of Spain, where government debt stood at 61 percent of GDP in 2011. Gross U.S. federal debt exceeded 115 percent of GDP. And that just records explicit debt. Unfunded obligations in the United States are staggering. U.S. medical liabilities exceed total world GDP. The present value of unfunded Medicare liabilities at the beginning of 2010 was a whopping $75.167 trillion. Add another $18.901 trillion for prescription drugs benefits, and unfunded medical liabilities on the U.S. balance sheet are $94.068 trillion—a sum about 25 percent greater than the total annual output of the world economy, put at $70.16 trillion by the CIA ($5 trillion above the estimate of the
Economist
).
7

Deleveraging is a particularly painful process when it depends upon the slow, incremental retirement of debt. Much of the progress of U.S. households toward debt reduction through December 2011 was the result of mortgage defaults. Write-offs were “running at around 2 percent of banks' secured loans” in the United States.
8

Typically, governments go more deeply into debt as households and nonfinancial corporations reduce indebtedness. This is because, as Richard Nixon famously said of himself and his fellow politicians, “We are all Keynesians now.” Nixon's uncharacteristic homage to a defunct economist was a confession of profligacy and open admission of the otherwise unspoken policy by which all advanced economies have operated since World War II.

John Maynard Keynes rationalized a turn to profligacy in his
General Theory of Employment, Interest and Money
(1936). This became holy writ for politicians in advanced countries. The central argument of the
General Theory
is that the level of employment is determined, not by the price of labor as the neoclassical economists argued, but by the spending of money (aggregate demand). Keynes wrote that government could improve economic prospects by spending money in almost any ridiculous fashion. He famously advised burying money in abandoned mine shafts so entrepreneurs would have an incentive to hire workers to dig it up. Politicians were only too delighted to discard the old-fashioned requirement to balance budgets. Consequently, after World War II all the advanced economies ran chronic deficits, bringing them to the point of insolvency. Among them, the United States has achieved the distinction of becoming the most thoroughly indebted country in the history of the world.

In the Keynesian perspective, attempts by households to reduce their debt mean a withdrawal of spending, which leads to a decline in aggregate demand. Australian Keynesian Billy Mitchell puts it this way: “As the private sector withdraws spending (aggregate demand) and starts reducing its debt levels, the only way that GDP can continue growing is if there is an external trade boom (unlikely overall) and/or fiscal support.”
9

It is unclear that this is true, however, even in Keynesian terms. The largest contribution to deleveraging in the United States household sector has arisen from debt default. Underwater homeowners who determined to stop paying their mortgages would in most cases have increased aggregate demand by diverting their mortgage payments to other uses. The backlog of foreclosure cases in the United States has been so great that homeowners who stopped paying their mortgages could, on average, live in their homes rent free for about a year and a half.

In any event, deleveraging is underway, and the typical response of governments is to run larger deficits to keep GDP rising. Over the long run, this is unsustainable. At some point, the government's good credit is exhausted. Without economic growth, the government's ability to borrow ever-growing amounts on the security of its taxing power is eclipsed. The Keynesian end point brings retrenchment that aggravates other deflationary forces.