September 11th. Iraq. Afghanistan. Iran. Weapons of mass destruction. Economic calamity. Foreclosure. Record unemployment.
According to Secretary of Defense Leon Panetta, these factors conspired to make the last decade one of turmoil. “Uncommon courage” combined with the strength and resilience of the American spirit will be required of our public servants and citizen leaders to forge ahead, securing the American dream for generations to come.
In a wide-ranging address hosted by the McConnell Center at the University of Louisville on March 1, 2012, Secretary Panetta cited the ever-growing national debt and federal deficit as one of the greatest threats to America’s national security. The Secretary argued that we needed to make comprehensive decisions about both federal spending and revenues so that we may “put America’s fiscal house in order.”
The grave threat posed by our national debt and deficit were crystallized when the Secretary cited three examples of his leadership during the Q&A period, all having to do with deficit reductions. While serving on the House Budget Committee (1979-85) and as its Chairman (1989-1993), Panetta helped develop deficit reduction plans, totaling nearly $1 trillion. Then, as the Director of the Office of Management and Budget under President Clinton, Panetta once again assisted in cutting the deficit by roughly $500 billion. As Secretary of Defense, Panetta has proposed a reduction in defense spending by nearly $500 billion over ten years (he continues to ask Congress to eliminate further defense spending cuts of another $500 billion).
In combination, Panetta has been instrumental in cutting more than $2 trillion from the federal deficit (and spending) over the past three decades. And, although it went without saying, Mr. Panetta seemed all too aware of the irony, knowing that during fiscal years 2010-12 the federal deficit has grown at an average annual rate of $1.3 trillion. Instead of pointing this out, the Secretary simply concluded by saying that he “regrets that we’re in the same damn hole again.”
America has overcome crisis and adversity time and again with leadership, sacrifice, and a willingness to fight—we must bring these same traits to bear today to secure our national sovereignty.
Secretary Panetta offered the audience a short story to better illustrate the American spirit and our willingness to fight: a rabbi and priest go to a boxing match in hopes of better understanding one another’s religions. Before the match begins one of the boxers crosses himself so the rabbi asks the priest what that means. The priest replies, “not a damn thing unless he fights to win.”
Secretary Panetta likened the tale to modern America. Americans, he says, have grown complacent, convincing ourselves that everything will be fine. Panetta pauses before conlcuding, “it doesn’t mean a damn thing unless we’re willing to fight for it. We all pledge to fight for the American dream; for an America that will be of, by, and for the people.”
Catastrophic. What if federal interest obligations were, suddenly, to double -- or worse?
The Wall Street Journal, in its lead March 12 Review and Outlook, "Uncle Sam's Teaser Rate" observes:
If the government had to pay the 5% rate that it was offering before the financial crisis on today's debt, the annual interest payments would be $535 billion, twice CBO's projection for total federal spending on Medicaid this year. If Uncle Sam had to pay 6% on its debt, the annual interest payments of $642 billion would surpass total federal spending on Medicare, currently $484 billion. Such a radical change in budget math could trigger a political panic and intense pressure for tax increases, perhaps even for a European-style value-added tax.
President Obama may not mind this outcome but Mitt Romney and Rick Santorum should, which is why they need to talk about this fiscal nitroglycerin that Mr. Obama and Fed Chairman Ben Bernanke have created. The two Republicans might also take a moment to wonder how much they really want this job. The next Presidential term may be spent trying to defuse the Obama debt bomb.
One year ago, testifying before the U.S. House of Representatives Subcommittee on Domestic Monetary Policy TLI's founder and chairman Lewis E. Lehrman made precisely the same point, reported by Forbes.com contributor (and, subsequently, advisor to thegoldstandardnow.org) Charles Kadlec, who wrote:
The Federal government’s fiscal emergency ... will not be entitlement spending. Rather, the driver of the fiscal crisis will be an uncontrolled $800 billion explosion in annual interest payments on the federal debt to potentially $1 trillion per year over the next five years. Such a super-charged ramp up in spending will more than offset even the most ambitious ideas now being discussed to reduce the Federal budget deficit over the next 10 years.
This conclusion is based on an extraordinary, but virtually unreported, testimony elicited by Congressman David Schweikert from financier and philanthropist Lewis E. Lehrman during Congressman Ron Paul’s hearings last week on Monetary Policy and Rising Prices. (Watch here.)
Schweikert noted his concern that the weighted average maturity of the Federal debt (WAM) was “somewhat dangerously short.” Lehrman pointed out that the average maturity of the debt is approximately four years and made the following startling point:
“Were the level of debt service payments to rise to close to market rates which are typical of full employment, the level of debt service payments would rise by an order of magnitude and consume a part of the federal budget which today is almost unthinkable and could only be four or five years away.”
Though the prospects of this fiscal emergency were clearly noted more than a year ago in The New York Times and the Washington Examiner, their reports went dangerously unnoticed as the nation was pre-occupied with the weak economy and the debate over ObamaCare. But now, with the debate over the budget and the prospect of higher inflation and interest rates in the news, let us hope that Lehrman’s candid testimony triggers the actions necessary to avoid this looming crisis.
Shortly after these hearings, George Melloan, a former columnist and deputy editor of the Journal editorial page, made a comparable point in the Journal in a piece entitled The Fed Has Trapped Itself on Rates.
The Fed has been committing an ancient sin that has tripped up many a banker: borrowing short and lending long. Although this is a common practice—for example, issuing one-year CDs to depositors to buy 30-year mortgages—it involves an inherent vulnerability. The bank makes its money on the differential between the low interest rate on short-term borrowing and the higher rate it gets on long-term lending. But if its long-term portfolio suddenly loses value, the bank is subject to a large loss that eats into its capital and jeopardizes its ability to continue attracting short-term investment. Banks go broke that way.
Last year, the Fed launched a second round of quantitative easing, QE2, in which it set about to buy $600 billion in Treasury bonds and notes as a form of economic stimulation. As the current sluggishness of the economy makes evident, there hasn't been much stimulus. But the Fed has helped the U.S. Treasury finance a massive federal $1.6 trillion deficit and refinance the maturing portion of the $14 trillion national debt.
The Fed has not bought up Treasury bonds and notes with newly created money. Instead, it has been getting its $600 billion by borrowing from the vast excess reserves owned by the private banks. These are deposits with the Fed in excess of those required by law. They expanded enormously post-2008, when the Fed was creating new money to replace the liquidity the banks had lost in the market crash.
The Fed is borrowing the money cheaply, at only a quarter of a percent interest rate. The Treasurys it buys yield over 3%. Meanwhile, the Fed can claim that it also is "immobilizing" reserves that, if loaned into the economy, could be inflationary. Sounds pretty clever, doesn't it?
It sounds even more clever when you look at last year's robust earnings of the 12 Federal Reserve banks. For 2010, they posted combined earnings of $81.7 billion, about $6 billion shy of the earnings of the entire commercial and savings bank industry. By law, the U.S. Treasury got most of this bonanza, $79.3 billion, with some $1.4 billion going into dividends to member banks and less than $1 billion to expand Reserve bank capital. It looked like nothing short of a heroic performance by the much-criticized Fed.
But the Fed is running a big interest-rate risk. Over the past few years, the Fed has borrowed about $1 trillion in excess reserves from member banks. The banks can call in those loans to the Fed on demand, which is about as short-term as you can get. Should the economy pick up and banks need that money to make private loans, the Fed would have to offer a higher rate to try to hold those reserves. But when interest rates go up, the value of bonds goes down—and so too would the market value of the Fed's $2 trillion-plus portfolio of Treasurys and mortgage-backed securities.
Writing in Forbes.com on May 6, William F. Ford (a former Atlanta Fed president) and Walker F. Todd (who did stints with both the Cleveland and New York Feds as a lawyer and economist) note that a one percentage point rise in long-term interest rates would lower the market value of the Fed's current bond portfolio by $100 billion. That would more than wipe out the $81.7 billion in earnings the Fed reported for 2010.
The reserve banks' skimpy capital base could be wiped out. Federal Reserve banks don't adhere to the asset-to-capital requirements imposed on private banks. And according to Messrs. Ford and Todd, the New York Fed has an "astounding" 98-1 leverage ratio—worse than Fannie Mae in its heyday.
Melloan, again, writing in the February issue of The American Spectator, points to the solution: Let's Return to the Gold Standard.
Subheaded: Ron Paul and Lewis Lehrman have been right all along, never more so than in this age of massive debt.
One question I've heard more lately: Now that the gold price is over $1,500 an ounce, shouldn't the U.S. sell its gold reserves—which were mostly acquired from U.S. citizens in 1933 at $20.67 or bought at $35 an ounce under the post-World War II Bretton Woods monetary system?
The BRICS — Brazil, Russia, India, China and South Africa -- are a bloc of emerging economic powerhouses, most of whom have been aggressively critical of US dollar depreciation policy. This writer long has believed that one of the major factors that will bring gold back into G20 consideration will be to "follow the yellow BRIC road."
In the past week, deeply respected monetary statesman and former deputy governor of the Reserve Bank of India S. S. Tarapore has published two articles, here and here, pointing out benefits of the classical gold standard.
As heard on Lou Dobbs Tonight, the evening of May 24, 2011:
Lewis E Lehrman stated:
"...this problem of eliminating the budget deficit of a trillion and a half dollars is something that cannot be done overnight. The proposal by Paul Ryan was very dramatic, one Republican called it radical, (was) not happily received. The solution of course is to design an American program for prosperity, because you can solve these entitlement problems with a growing economy."