The Lit Fuse

While the US and some other world governments have taken some serious financial risks with overspending and excessive debt load, companies and banks around the world are taking even more startling financial risks. Some of those could easily crash the world financial system even if the governments all had no debt and strong finances. Let’s take a look at the worst financial risk — the worldwide derivatives market.

What is a derivative?

From Wikipedia:

A derivative is a term that refers to a wide variety of financial instruments or "contract whose value is derived from the performance of underlying market factors, such as market securities or indices, interest rates, currency exchange rates, and commodity, credit, and equity prices. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof."

So what are derivatives, really? Essentially, a derivative is a contract that is entered into as a gamble, involving some future exchange of money that could either be at a profit or a loss. There are many types, including:

Swaps, in which one future cash flow is traded for another
Futures, in which a future purchase/payment is promised at a fixed price
Options, in which money is paid for the right to make a future purchase at a fixed price

Let’s look at some examples.

A swap is arranged between two bond funds where the future payouts are exchanged for a price. If one of the bond funds tanks and its payouts drop, the other bond fund who exchanged for its payout loses money. Similarly, if one of the bond funds soars, since it is now paying the other bond fund money is lost.

A futures contract is arranged between a corn farmer and an ethanol producer. At the end of the harvest all of the corn will be sold to the producer for a fixed price per bushel, agreed upon now. If corn drops in price by then, the producer will have paid too much for the corn. If corn soars in price by then, the farmer will have received too little for the corn.

An options contract is arranged where an investor pays a broker for the right to buy Acme Corporation’s stock at $5 more per share than its current price, 90 days in the future. The payment is made because the broker is taking a risk: if the stock’s price rises more than $5 by then, the broker will have to sell the specified amount of stock to the investor and the broker will lose money. If the stock doesn’t rise enough, the investor won’t exercise the option and the broker will keep the initial payment.

Although the details of these financial arrangements are often quite complex, they are all just speculation, no different than purchasing shares of stock. Any derivative can make or lose money depending on future events that cannot accurately be predicted in advance.

Why are derivatives used?

Derivatives were invented as a means of lowering risk. In the example above with the futures contract, while he might end up paying more than he would have, the ethanol producer is lowering his risk overall by knowing in advance what he will pay for the corn he needs. Derivatives are often used to hedge, meaning, as a way to limit losses incurred by a companion investment.

Unfortunately, more and more derivatives have been used as massive speculative gambles. Since derivatives are so complicated, banks and fund managers can use them to hide from their investors the level of risk they are taking.

Why are derivatives a worldwide problem?

All derivatives vary in value as the future unfolds. In the example of the futures contract between the corn farmer and the ethanol producer, at first the value will likely be zero as they have agreed on a price that they think will even out, so that neither of them loses money on the deal. As the farming season goes on, if a drought occurred and the price of corn skyrockets, the derivative will be a major asset to the ethanol producer and a major liability to the farmer. If instead the growing conditions were far better than expected and corn yields higher than normal, making the price of corn drop, the derivative would be an asset to the farmer and a liability to the ethanol producer. Derivatives are volatile; the value of a derivative can swing wildly as conditions change, alternating between being an asset and being a liability or rising and falling as an asset or a liability.

The volatility of derivatives isn’t a problem by itself. It’s the staggering level of use to which they have risen in the United States and around the world. In late 2012, the Comptroller of the Currency Administrator of National Banks issued a report that US banks were holding $227 trillion in derivatives. Yes, that was two hundred and twenty seven trillion dollars! In volatile derivatives that are gambles that can change in value. The top 25 banks in the United States together hold $212 trillion in derivatives. The total combined assets of those banks are less than $9 trillion.

Imagine those 25 banks’ derivatives dropped just 5% in value. This would be a loss of more than $10 trillion — more than all of their assets combined and far more than enough to completely wipe all of them out. In fact, a drop of only 2% would lose them almost half of all of their assets, which would likely wipe them all out. The Federal Deposit Insurance Corporation (FDIC) would have to step in and repay millions of account holders up to $250,000 for each account lost, which would require trillions of dollars. Where would this money come from?

Even worse, the worldwide derivatives market is estimated to be $600 trillion. The entire world’s GDP is estimated to be around $70 trillion – less than 12% of the derivatives market. Imagine a 2% loss of $600 trillion ($12 trillion) compared to GDP? Or a 5% loss ($30 trillion)?

There have already been huge losses from using derivatives. Barings Bank was once the oldest merchant bank in London, founded in 1762. In 1995, it collapsed because it lost $1.3 billion from investing in derivatives – mainly futures contracts. In 2009, Morgan Stanley had lost $9 billion in derivatives – mainly credit default swaps – and was bailed out by Mitsubishi UFJ . In 2008, Société Générale of France lost $7.2 billion, mostly from derivatives trading. In 2006, Amaranth Advisors collapsed after losing $6 billion in derivatives – natural gas futures contracts. The list goes on.

Imagine you found out that your bank was taking all of its investors’ money and gambling with it. How would you feel about the safety of your money? The $227 trillion on the line in the United States and the $600 trillion or more worldwide is a whole lot of gambling, and at any time, the worldwide financial system could collapse from a few bets gone wrong. The world’s financial system is now a house of cards.

In this series of articles on insolvency, we’ve seen that:

• The Federal government takes in about $2.5 trillion in tax revenue – In Joe’s terms, a $25,000 salary.
• The Federal government is spending much more than it gets in revenue – in excess of $1 trillion more, which would be Joe spending an extra $10,000 per year (spending $35,000 a year when he makes $25,000).
• Our governments at the federal, state, and local levels collectively owe a lot of money – somewhere around $20 trillion, which is like Joe owing $200,000 to creditors.
• The government has large and looming unfunded liabilities – somewhere around $100 trillion of today’s dollars, which would be like Joe needing an $1,000,000 in the bank right now to cover his future obligations. These unfunded liabilities will inevitably worsen the deficit, which will increase the debt.
• Governments at all levels are already paying a lot to meet the interest obligations of their debt, and that’s with very low interest rates. The principal of the debt is not being paid down, and is in fact increasing rapidly.
• The Federal government can only default on its debts if it chooses to, because it has the power to print its own money, but such actions have serious consequences. Sooner or later, paying debts with newly printed money will result in a currency collapse, which is true insolvency.

Can insolvency be avoided?

What would we need to do to prevent insolvency? It’s actually fairly simple: we would need to eliminate the deficit, by spending only what we get in revenue. Inflation would slowly whittle down the value of the current debt until finally we could begin to pay it off.

Unfortunately, something being simple doesn’t mean that it is easy.

To eliminate the deficit, we would have to reduce spending, increase revenue, or use some combination of both, that added up to more than $1 trillion dollars a year. In addition, we would have to either reduce the unfunded liabilities by taking away some of the benefits that have been promised to people, or reduce other spending to make room to pay for them.

Let’s look first at the numbers. What are we getting in revenue, and from where? What are we spending, and where is the money going? Let’s look at income first. These 2012 numbers come from the President’s 2013 budget on the White House’s web site:

Revenue in 2012

Category	Amount (in billions)
Individual income tax	1,179
Social Security payroll tax	635
Medicare payroll tax	203
Other retirement collections	9
Corporate taxes	281
Customs duties	31
Excise tax	80
Estate/gift tax	7
Unemployment insurance	57
Federal reserve deposits	81
Other	24
Total	2,590

 
What revenue might be raised? Let’s look at these revenue items.

Personal taxes such as income tax and payroll taxes would be very difficult to increase significantly. The article Who Pays? shows that the bottom two-thirds of all tax returns make less than $50,000 a year and pay less than 10% of all of the federal taxes. Most of them would suffer from any significant tax increase. How long can a politician stay in office after doing something that is deeply unpopular with two thirds of the voting public? Knowing this, our government is not planning any significant tax increases for that segment of the population.

Let’s consider a whopping 20% income/payroll tax hike on everyone else – those making $50,000 or more. They pay 90% of all federal income taxes (about $900 billion in 2009) so a 20% increase would only mean about $180 billion in revenue – and that is if people actually paid the increased taxes. Hauser’s Law, mentioned in the article What is Progressive Taxation?, shows that the government is limited in what it can collect in taxes because beyond a certain point, revenues do not increase. The UK recently came up against this when they attempted to raise the top tax rate to 50% on incomes of £1 million. From a newspaper article:

Almost two-thirds of the country’s million-pound earners disappeared from Britain after the introduction of the 50p top rate of tax, figures have disclosed. In the 2009-10 tax year, more than 16,000 people declared an annual income of more than £1 million to HM Revenue and Customs. This number fell to just 6,000 after Gordon Brown introduced the new 50p top rate of income tax shortly before the last general election. The figures have been seized upon by the Conservatives to claim that increasing the highest rate of tax actually led to a loss in revenues for the Government. It is believed that rich Britons moved abroad or took steps to avoid paying the new levy by reducing their taxable incomes. […] Last night, Harriet Baldwin, the Conservative MP who uncovered the latest figures, said: "Labour’s ideological tax hike led to a tax cull of millionaires. Far from raising funds, it actually cost the UK £7 billion in lost tax revenue."

A 20% income tax increase would give the United States a top tax rate of 49.87%: 39.6% increased to 47.52%, plus 1.45% Medicare tax and 0.9% additional Medicare tax. Even if all or part of it was disguised by raising payroll taxes, such as raising FICA to tax all income rather than it having a ceiling, no one will be fooled. This is almost exactly equal to the 50% rate that the UK enacted, but it would affect more people because it would apply to a far lower income threshold – around $400,000 rather than £1 million (about $1.5 million in US dollars). We would see a similar result, or likely even worse as so many more people would be affected. There are many means for higher earners to avoid taxes. They can hide income, shift income offshore, or even leave their country to emigrate to somewhere with lower taxes. Gerard Depardieu and Tina Turner are two recent examples of this kind of "tax flight". The federal Congress is extremely unlikely to attempt raise taxes this much, but even if they did and no one avoided the increase, it would raise only about $180 billion.

Corporate taxes in the United States are already among the highest in the world. Any significant increase would cause some businesses to close. Others would avoid the taxes by moving some or all of their operations offshore. Not only would we lose revenue, but we would lose jobs as well. Customs duties could not be raised much without retaliation from other countries, which would cause more losses than the increased revenue. Still, let’s say we could raise both of those things the same whopping 20% we tried on individuals, and somehow no businesses closed or avoided the taxes. We’d only raise around $60 billion. Raising excise and estate/gift taxes would cause more tax avoidance, but let’s say it didn’t and we managed to raise those by 20%, too. We’d raise less than $20 billion.

In summary, there really isn’t much of any room to raise tax rates further without causing damage, with a net effect of lower revenue, but if some kind of magic allowed us to raise most taxes 20% and somehow there was no tax avoidance, we’d get a total of $180 billion from income tax, $60 billion from corporate tax and customs duties, and $20 billion from other taxes, for a total of $260 billion. This is not even a quarter of the 2012 deficit of over $1.1 trillion.

Assuming we managed to raise that $260 billion, that would still leave an $840 billion deficit. The next item to look at is our spending. From USGovernmentSpending.com:

Spending in 2012

Category	Amount (billions)	Notes
Pensions	805.6	Includes social security and federal employee retirements
Health Care	866.1	Includes Medicare, Medicaid, and public health services
Education	121.1	Includes educational grants and some government research
Defense	925.2	Includes the military, veterans, and foreign economic aid
Welfare	431.5	Includes various welfare programs, SSI, and unemployment
Protection	58.7	Includes federal police, courts, and prisons
General Government	32.6	Includes core federal costs
Transportation	104.9	Includes federal highways and airports
Other Spending	141.5	Includes many government departments such as agriculture, community grants, and government research
Debt Interest	241.6	No principal paid
Total	3,729

 
Where do we cut $840 billion? Pensions such as Social Security, and Health Care such as Medicare, and Medicaid are widely considered untouchable. We will not see any significant reductions proposed for those items. In fact, they are set to increase far more than we have the funds to pay, and make up the bulk of the unfunded liabilities. Let’s ignore those for now, except to say it isn’t possible to see any savings on these items.

The rest of the spending totals $2057 billion. To cut $840 billion from this, we would need to cut an average of 40% across the board to all other programs. Congress is currently facing what is called the sequester, a set of automatic spending cuts that will add up to a paltry $85 billion in cuts per year – about 10% of the $840 billion we’ve outlined here – and we are seeing a serious reluctance to allow the cuts. Still, let’s go over what 40% cuts would mean.

In the education budget, about $50 billion goes to primary, secondary and vocational schools. About $22 billion goes to higher education. About $48 billion goes to various government programs, subsidies, and research items. Cutting 40% of these programs would mean $10 billion cut from schools, $4.4 billion from higher education, and almost $10 billion from those programs, many of which would have to be eliminated.

When people consider cutting defense, what they mean is the Department of Defense, which had a budget of about $708 billion of the $925 billion we spent on defense. We would need to cut the DOD’s budget by about $185 billion to make the 40% cut. How much can we cut this much from defense without leaving ourselves vulnerable?

Welfare is a difficult item to cut, and we’d need to cut it by more than $172 billion to make our 40% goal. Unemployment is funded by its own fees on businesses, so it’s off the table. Workers’ compensation (e.g., for disability) cost about $7 billion and can’t be reduced without significant reforms; similarly, SSI cost $47 billion and can’t be reduced without significant reforms. Such reforms are extremely unlikely to happen because they would need to restrict eligibility. Foster care cost about $7 billion and is a money-saver since taking care of the children otherwise would be far more expensive. The rest totals about $370 billion and would have to be cut more sharply – almost 50%. Many of these programs are now relied on; cutting them suddenly would cause a lot of pain. Aid to families and children gave out about $108 billion, almost all for food and nutrition programs; cut by $54 billion, millions would go hungry. Housing assistance cost $60 billion; cut to $30 billion, a huge segment of the population would be made homeless. TANF (temporary assistance to needy families, the traditional "welfare") only spent about $17 billion; cutting that by $8 billion would leave a lot of people helpless, many of whom are in dire need. The rest is in various items including tax credits, many of which would need to be eliminated, pushing people who rely on them into poverty or perhaps even over the edge. Cutting this $172 billion would cause so much pain and panic that it is inconceivable that it would happen.

The Protection and General Government categories are very difficult to cut. Police and courts are already overloaded. Cutting $18 billion here would certainly result in a reduction public safety and even further delays in obtaining justice.

Transportation would need to be cut by almost $42 billion. We already are not spending enough on our highways and bridges, which are falling into greater and greater disrepair; this is sometimes referred to as the "third deficit". We would have to cut highway spending from $72 billion to $43 billion, with catastrophic results. Cutting air transportation from $23 billion to $14 billion would mean the end of the TSA, since air traffic controllers can’t be cut, which would invite terrorists back to our airports.

Cutting the final other spending category by $57 billion would mean the end of many community grants, which we spent $25 billion on, and severe cuts to agricultural ($26 billion), research ($17 billion), and energy programs ($16 billion). While we could cut these things, there would be an enormous number of complaints from those who benefit from the programs. Community grants, for example, often go to paying for extra police.

Even with all of these severe cuts, which won’t happen, we still have the unfunded liabilities to deal with, which will increase spending for programs such as Social Security, Medicare, and Medicaid. Every dollar of increased spending on these items would require even further reductions in other areas.

Summary

Increasing tax rates is unlikely to gain further revenue, and there is little agreement that taxes should be raised, leading to a lack of any action, so it is extremely unlikely that the government will gain much in tax revenues. In fact, as the economy gets worse, government will lose revenue, widening the deficit.

Cutting spending enough to help the deficit is extremely unlikely to occur. Instead, there are many both inside and outside of government who want to increase spending. With a lack of agreement, no action will be taken. Spending will stay the same, or increase from automatic increases. Social Security payments and Medicare spending are examples of spending that automatically increases.

Inflation won’t get us out of the debt, either, since the debt is increasing far too quickly. Besides that, sufficient inflation can and will bring about a currency crisis by itself.

Because of the extreme unlikelihood of either revenue increases or significant spending cuts, we are on our way to national insolvency. The fuse has been lit, and it isn’t being put out.

Watch Congress carefully. They would need to enact huge tax increases and Draconian spending cuts to deal with the deficit — and soon. If they do not, insolvency is inevitable.

In our previous posts in this series, we’ve established that the United States government is spending about $1 trillion more than they get in revenues, has accumulated somewhere around $20 trillion in debt of various kinds, and has unfunded liabilities so high that they would need perhaps as much as $100 trillion in the bank right now to cover the future expense.

Why is this debt a serious problem?

It is a problem for the same reason that high personal debt is a problem. Debt has to be repaid, and while it is being repaid, it has to be serviced – meaning, the interest has to be paid. The higher the debt goes, the higher the cost to service it goes, and the higher the cost to repay it goes.

How much interest did the US government pay on its debt in 2012? Close to $360 billion, according to the US treasury. Let’s go back to our fictional example of Joe, who makes $25,000 a year, spends $35,000 a year, owes $200,000 in borrowed money, and needs $1 million in the bank to keep his promise to his parents to support their retirement. The government’s debt interest scaled to Joe’s world represents a payment of $3,600 a year, or about 14% of what Joe makes in a year. While this doesn’t sound too bad, it’s only this low a payment because Joe has borrowed his money at a very low interest rate: from 1% to 2.5% depending on the lender. Also, Joe is paying interest only and not paying any principal, so the debt is only being serviced and not repaid. To approximate Joe’s $3,600 a year in payments, we’d use a blended interest rate of 1.8%: $200,000 times 1.8% is $3,600.

Credit in the world is a limited commodity, at least until governments start printing fiat currency*. What happens to any limited commodity as it is bought up? It gets more expensive. In addition, as the fiscal weakness of the United States becomes more and more obvious, lenders see the increased risk, so the cost of credit rises. The cost of credit is expressed in its terms, which usually means the interest rate. Let’s say Joe goes on another five years without changing his ways. At the start he’s spending $10,000 a year more than he makes, and now, his parents’ expenses add somewhere around $13,333 a year. He has to service the debt as it rises, so his deficit rises and debt grows from $200,000 to $340,000. The extra $140,000 would have made his annual debt payment grow to $6,120 if he had been able to borrow at the original interest rates, but Joe’s creditors are getting wary of his debt and income level, and have now raised his rates to 3.6% on the newly borrowed funds – still a fairly low rate, but now, Joe’s annual debt service costs him $8,640. This is 2.4 times what it used to cost, and raises his annual spending from $35,000 to about $40,000 a year. His debt service has gone from about 14% of what he makes to more than 34%. If Joe continues on in this way, eventually the cost of servicing his debt will be higher than what he makes. While Joe might succeed using tricks such as borrowing more money to pay the existing debt’s interest, eventually he will become insolvent by defaulting on his debt service. 
* Fiat currency means the government pays their bills by printing up new money that isn’t backed by anything. Printing fiat currency in large amounts causes existing money to lose value, triggers severe inflation, and often causes a currency crisis. This will be covered in a later post.

Now let’s look at the option of Joe attempting to repay his debt before this happens. What might Joe do, given his $10,000 overspending, $200,000 in debt at 1.8% annual interest, and $1 million in unfunded liabilities which averages about $13,333 a year in additional spending?

• Joe would immediately have to lower all his spending so that it did not total more than he makes, meaning his deficit would have to go to zero.
• If Joe were to attempt to repay his debt over 30 years, like a standard mortgage, it would take $8,632 a year in both interest and principal — much more than the $3,600 he’s paying now.
• Joe is still committed to paying his parents’ retirement bills, which is projected to require $13,333 a year.
• To cover just the obligations of his debt payment and unfunded liabilities, Joe would have to spend $21,965 a year – leaving Joe with just $3,035 a year, or about $250 a month to pay all of his own bills.
• Currently, Joe is spending about $31,400 a year on his own bills — $35,000 minus the $3,600 debt service.

So, to maintain the same life he had, and meet all of his obligations, Joe would need to increase his income from $25,000 a year to $53,365 – more than double what he makes now. Since this is unlikely to be possible, he’s going to have to figure out some combination increasing income, not meeting on his obligations, and/or extreme cost-cutting in his lifestyle to make the numbers work. Worst of all, this is the picture now. If Joe goes on 5 years and owes $340,000 instead of $200,000, with a higher blended interest rate, the picture is far more bleak. The annual payment on the additional $140,000 at 3.6% would be $7,638 – meaning just to make his debt payment and obligations would cost Joe $29,603 a year, more than he makes without even spending a penny on his rent or other bills.

If we scale all of these numbers up to our government’s revenue, spending, and debt, it means that just like with Joe’s income, taxes on individuals and businesses would have to more than double for the government to have the revenue they would need to pay off our debt in 30 years and meet their obligations – except that history has shown that raising tax rates does not significantly raise the amount of taxes collected*. So there would have to be some combination of tax increases, spending cuts, and/or lowering of the cost of obligations like Social Security and Medicare would be required – often referred to as austerity measures — and again, worst of all, this would have to happen right now. Every day we don’t do these things means we accumulate up more debt, and the choices become more and more painful. 
See "Hauser’s Law" reference in post on Progressive Taxation for more information.

If our government gets into debt deeply enough, just as with Joe and his fictional financial woes, insolvency will become unavoidable. I believe it already is unavoidable.

In the next post we will examine the possible effects of government insolvency.

What is the national debt?

In the last article, we explained the deficit – the amount the government spends in excess of what it receives in revenue. Year after year, the deficit adds to the debt. The government has run sizeable deficits since Ronald Reagan became president*, and the debt has piled up year after year. 
* Some incorrectly state that president Clinton did not run a deficit for part of his presidency. Unfortunately, he did run a constant deficit in the hundreds of billions or more even though the official numbers showed a surplus. The government used accounting tricks such as off-budget spending to hide large amounts of spending; see this article for details.

How much is this debt at this time?

Borrowed Federal money adds up to around $16.4 trillion dollars. States collectively owe somewhere around $1.1 trillion, and local entities such as towns collectively owe around $1.7 trillion, for a total of $19.2 trillion. Add to this the structural deficits – federal, state and local governments are all delaying maintenance on roads, bridges, and other structures, and it ends up somewhere around $20 trillion.

Consider how much money this is. In a previous post, "Who pays"?, we examined who pays taxes and how much. In 2009 there were 141,458,638 tax returns filed. For 2012, let’s round that up to 150 million. If we divide this $20 trillion equally among all 150 million tax filers, it would be $133,333.33 for each – an almost mortgage-sized debt. Paying this off in 30 years, at only 2% interest, would require each and every taxpayer to pay $492.83 a month. This is more than many low earners’ take home pay, so it wouldn’t work.

Next let’s try shifting the debt repayment up to those who could more afford such a payment – those making $50,000 a year or more. There are only about 50 million such taxpayers, so now the debt per taxpayer would be $400,000 – a large mortgage-sized debt. Paying this off in 30 years at only 2% interest would require those making $50,000 or more to shell out $1,478.48 a month. A person making $50,000 would be losing about a third of their gross income, and closer to half of their current take-home pay. This wouldn’t work either – it’s too much of a burden. It would reduce people’s income so much that they’d decide either not to work at all, or to take lower income jobs that would leave them with just as much money after avoiding the debt repayment.

Finally, let’s try shifting the debt repayment up to higher level earners, who make $200,000 or more. There are only about 4 million taxpayers in that category, so the share of debt each would be a whopping $5 million each. Paying this off in 30 years at 2% interest would require $18,480.97 a month, or $221,772 a year. Since that’s more than the entire income of the low end of the group, even before taxes are deducted, it obviously wouldn’t work.

Now let’s look at debt repayment from a progressive view. What if we assessed a special, graduated tax in proportion to earnings in an attempt to avoid an impossible burden on anyone? To repay the debt over 30 years, at 2% interest, we would need to pay around $74 billion a month, or $887 billion a year. The US Debt Clock lists the current tax collections for people and corporations as a total of around $1.4 trillion, so this $887 billion would require an overall tax hike of almost two-thirds.

In theory, a two-thirds overall tax hike may sound possible, but it isn’t. Studies have been done on the ability of the United States to collect taxes on its citizens. As mentioned in a previous post, "What is Progressive Taxation?", it isn’t possible to increase taxation that much. The government has tried in the past to raise tax rates significantly, and it did not result in a significant increase in revenue. In fact, if taxes are raised enough, revenue begins to decline. This is from factors such as people hiding or shielding their income, or even removing their money from the economy entirely as “tax exiles”. In addition, significant increases in tax rates cause businesses to fail and close, which removes both the business’ and its employees’ incomes from the economy.

The deficits are still so high that the debt is growing rapidly. Let’s scale the debt down to our fictitious example of Joe, who makes $24,000 a year after taxes but is spending $34,000. The $20 trillion in debt built up is like Joe having $200,000 in debt – more than eight times what he brings home in a year! That would be bad enough by itself, but before Joe could even begin dealing with his debt problem, he would need to cut his spending significantly. The majority of the citizens of the United States are not showing any will to cut spending, so imagine that Joe simply refuses to spend less, and in fact, starts to spend more!

Worst of all, that $20 trillion and counting in debt is only the beginning of the story. The next post in the series deals with unfunded liabilities – what the government has promised to pay for, such as Medicare and Social Security, but does not have enough money set aside to pay the projected amounts.

Insolvent: adjective
1: unable to pay debts as they fall due
2: having liabilities greater than the market value of assets held

The United States government has racked up massive debt by spending far more than its revenues. Like a person with a limited income and bills to pay, if the debt grows large enough, the government will be unable to pay the interest on the debt and will therefore be insolvent.

This series of posts addresses these questions:

• What is the deficit?
• What is the national debt?
• What are our unfunded liabilities?
• Why is the debt a serious problem?
• What happens if the United States does become insolvent?
• Is insolvency avoidable?
• What should I do?

These are all very important questions. It is my opinion that insolvency is already unavoidable except by means that will be an even greater disaster, such as hyperinflation.

To see some of the numbers involved in this series in realtime, along with some past years and estimates of the future, see the US debt clock.