Mutual assured destruction, M.A.D., is the term du jour out of Washington and Wall Street over the past 3 or so years. Regardless of who is in charge there seems to be fear mongering for every situation in today’s world. The latest MAD scare is over the debt ceiling and if it is not raised the world will stop and we all will die. I can assure you that none of this is true and the sun will surely rise and set the day after if the debt ceiling is not increased.

I am not saying that by not increasing the debt ceiling everything will be fine, but I am saying it is not as bad as we are all being told. It is insane to believe that the world will shut down if the debt ceiling is not increased and the fear mongering must stop. If the debt ceiling is not raised it simply means that government spending would slow down and be limited to what the Treasury Department collects everyday and no debt can be issued in excess of the designated debt ceiling. However, the debt that matures, since most interest is paid before maturity (I am simplifying this) the debt that has matured can in fact be rolled into longer term bonds. Basically, nothing major would happen right away but in time there may be issues.

What would happen is many federal employees would be fired and many agencies would close. Obviously this is not good news, but it is not horrible news either. The government collects some $200B in taxes or fees a month which means that all our debt servicing costs would be covered in just one month’s tax collection, obviously interest payments are spread out, but you get the idea. Interest rates will not rise out of control and we are not defaulting on our debt, don’t forget the Federal Reserve is our largest creditor and they hand over 95% of their profits to the treasury which reinforces my point since the government is paying interest to itself on over a trillion dollars of our debt.

If the debt ceiling is not raised things will be tough and unemployment, from government employees, will rise but life will go on and much of the private sector will remain untouched. In fact the private sector might just flourish since many regulations could not be enforced because government agencies are closed down. Subsidies would end and waste would be purged from the system, again I see no downside here. The government would be forced to live on what it collects and this clearly bothers the powers that be since they are buying political favor through wasteful spending.

Contrary to popular belief Social Security checks would go out and Medicare payments would still be paid since FICA withholdings cover these costs for now. Well, in theory that is what would happen, but since the government raids those programs excess reserves all the time they are not technically solvent. Even though these programs are safe through their own taxation Washington is telling you the exact opposite which is a lie unless they used those tax withholdings for something else. This is how MAD works though, scare you to death so you don’t question anything and do what you are told.

You see if the debt ceiling is not increased the house of cards begins to waver and that is the problem. The government and the powers that be do not want you to realize that this whole thing is very wobbly and unsound, meaning our economy. They do not want you want you to know that money is debt and the Federal Reserve cannot print money without being paid interest from the treasury department. They do not want you to know that things can get done on less money. They want to scare you into keeping the status quo which is on its last leg anyhow because debt cannot increase forever. Eventually everything comes to an end, look at Greece and Ireland.

Ultimately the debt ceiling will be increased without much of a fight some grandstanding of course, but no real resistance will come and the vote will come and go quietly. What is so crazy is the use of the MAD policy that is used for everything nowadays. No matter what is happening we are told that we are all going to die if so and so bill is not passed which is not true, ever. Why we all fall for this is beyond me, but most Americans do and insist that the wrong decision be made, i.e. preserving the status quo. However, the status quo is unsustainable even in the short-term and is completely evident when one looks at the value of the dollar and the price of commodities.

To be clear on my stance, I know longer term the debt ceiling must be increased as we would eventually default, but I am confident that the US could make it much longer than anyone thinks without issuing new debt. It is just most people who depend on the system for their survival would not like this and that is why the MAD card is being played. We should all be appalled that our leaders are using the MAD card so often and it should be perfectly clear to everyone that when the MAD card is played it is to preserve our leaders and it usually is not in our best interest to continue with their status quo. In time we must start to call our leaders out and see what would really happen if they do not get what they want and I am very sure that MAD will not happen.

I just read a Time Magazine article today about the U.S. debt and how it is no big deal the U.S. has so much debt. In fact, Zachary Karabell actually believes that our debt is a good thing. I have actually met Mr. Karabell last year at a conference we both spoke at, although he was paid and I was merely on a panel, but it is unlikely he would remember me. Regardless, I have to humbly disagree with the conclusions he came up with in his article.

Debt can be a good thing, but only in small amounts and for productive reasons. For example, a business that takes out a loan to hire a new employee to expand their business would be productive debt as it contributes to society, hopefully. However, taking out a loan to buy a 50” high definition TV is, in my opinion, a terrible reason to add debt to ones balance sheet. The U.S. government borrows money, recently, to hire people and encourage spending, but the government is not creating productive jobs because it creates nothing and it must tax the people in order to pay off the debt for the job it created. The government actually destroys wealth through taxation and wasteful spending. Basically, the government is borrowing money to buy big screen TV’s, bad debt.

The U.S. government does need to carry debt because we are the reserve currency and carry trade deficits. Debt for a government could be a good thing if that country is the reserve currency, but there is a point where too much debt is the ultimate problem. The impact of too much debt over time during strong economic times may not be a major problem because a growing GDP means more tax revenue is being collected and should increase over time as long as conditions are good. However, any economy has cycles where there are good and bad times, we are currently experiencing bad times, and when times get bad that large debt load becomes a problem and is no longer good, Greece is a good example of this, kind of.

Excess debt during poor economic times means tax revenues decline and the government will have to run deficits to pay for its spending, I am way over simplifying this. Generally, a government will spend much more during these bad times to spur the economy, known as the Keynesian Theory, but this spending, in my opinion, is not the way to spur the economy. As the debt builds and the central bank cuts interest rates the debt during these bad times might not seem so bad because the country has artificially lowered the cost of borrowing, again to spur growth. The key word is “artificially” lowered interest rates and the current interest rate may not actually reflect the current economic conditions or the risk of holding said countries government debt. The reason people ignore deficits more during lower interest rate periods is because the cost to carry the debt is so low, like now.

The U.S. currently has over $12T in debt, heading much higher rapidly, but the carrying costs of that debt is about $500B a year. Keep in mind this is because the Fed Funds Rate is at .25% which means yields on the U.S. government debt is very low, artificially low. The government can currently borrow money for 30 years, for those crazy enough to buy it, for less than 5%, not a bad deal, right? However, what happens if the bulls are right and the economy is recovering and rates have to increase? A 1% increase in Fed Funds would mean the aggregate increase on our debt would be roughly .70%, most of our debt matures in less than 10 years, not good I might add. That means our debt servicing costs, the interest we pay, would increase to about $600B a year, still not bad.

The problems start to get real bad when the Fed increases rates to say 3% or so. The cost to borrow on the 30 year treasury would go up dramatically to about 6%, on the conservative side, and even out short-term interest rates on our bills and notes would go substantially, everything is relative, higher. Before I go further you have to remember that debt is a deadly circular beast because the more you borrow the more you have to pay back and during rising interest rates in order to make all of your payments you either have to tax the people or have more deficit spending, guess which will win in the U.S.? If rates go to 3% because of a hot economy the interest on our debt servicing costs will quickly rise to about $800-$900B, depending. It will take no time at all for the interest payments to reach $1T and considering our debt mostly matures 10 years or less you cannot forget the refunding that must take place. The CBO just did an estimate on a lot of this in the past few days, I did not read the report, but I know the final numbers without a lot of obvious assumptions end up close to what I just said.

Karabell makes the argument that the U.S. would use the borrowed money to retrain our workforce and rebuild our infrastructure. That may be the case, but to fully upgrade our infrastructure, not including pie in the sky green energy items, would cost about $2T. I believe the last stimulus only applied a small portion of what is needed, so the infrastructure idea Karabell had does not pan out in my book. Plus, there is no return on infrastructure immediately, over time yes because it makes commerce easier, but that takes time. He also made the case that China and India are flush with cash and building their infrastructure now and, I think, was indicating that since the U.S. is so stable that excess cash will end up here, which is reasonable to assume, for now.

What he failed to address is the fact that the money they are flush with is ours from them exporting goods to us. Because they have such huge exports to the U.S. we have a trade deficit with them and they need to buy our debt to balance it out. It is a case of vendor financing and all vendor financing ends up with someone getting hurt, guess who in our case? The point I am making is that the Chinese and Indians will buy our debt now because treasuries are going up in value, thank you deflation, but how long will that continue for? Not only that, but if China un-pegs their currency from ours it will appreciate and their treasury holding, in RMB terms, will decline. Why would one invest in treasuries if your currency is rising and the country you are loaning money to as a declining currency, you wouldn’t do that.

Essentially, all gravy trains end and there is a limit to how much a country can borrow. Consider the U.S. has implicit guarantees on not only our debt, but also on banks, insurance companies and the mother of all bad investments the GSE’s. Oh, and if you ever expect to see GM pay back the money they got, well, I wouldn’t hold my breath on that one. All of those guarantees are about $23T, not including the national debt and the entitlement guarantees we have. Again, my point is the limit to what the market will allow a country to borrow cannot be far off. At the very least we will need to pay a greater risk premium on our debt which means the interest rates on our government bonds will detach from where the Fed sets them at and go through the roof.

I get what Karabell is saying, but he is speaking in the here and now which is suicide when talking about so much money. You must look forward in order to see the real problems and it is kind of crazy to think that all this borrowing will go towards retraining the people and vastly improving our infrastructure. The government is the worst at spending money efficiently and much of that money goes to wasteful projects like DNA research on bears in Montana, no offense to bears, but I just do not care about their DNA. On top of all that, who knows if we will actually emerge from this downturn, sorry I do not buy an inventory rebuild as a real economic recovery. If we do not exit this thing in the next10 months our problems will be bigger than we think.

On top of all of this there is the whole impact to our currency, which is not good. The more debt we issue the more we dilute our currency and at some point the world will demand some type of other reserve currency, it is being talked about now. If we lose our reserve currency status we are in a heap of trouble, I know that could ‘never happen.’ All of these problems or these potential problems leave me a couple of conclusions, besides the fact that bulls will spin even really dangerous debt problems positively, that; 1) Precious metals are cheap and 2) The Fed will never raise the Funds rate to a reasonable level again.