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The Daily Reckoning

Why the young are forced to pay the old's debts

Instead of families paying for their children’s education, they force the children to borrow the money from the government. Then, paying it back, the money is recycled to old people — through Social Security, Medicare, and so forth. How long will they put up with it?

By Guest blogger / February 23, 2012

In this file photo, Gan Golan, of Los Angeles, dressed as the "Master of Degrees," holds a ball and chain representing his college loan debt, during Occupy DC activities in Washington. Bonner argues that by taking out federal student loans, young people are actually helping support the old by funding programs like Social Security and Medicare.

Jacquelyn Martin/AP/File

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$100 billion down…

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Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning (dailyreckoning.com).

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$40 trillion left to go!

Hey, don’t hold us to those figures. But yesterday European sages cut another deal to stave off the truth. Instead of defaulting openly and honestly — as Greece has done over and over again ever since 1827 — the Greeks will be ‘rescued.’

Sayeth Lucas Papademos, the technocrat leading Greece through its vale of deceit:

“It’s no exaggeration to say that today is a historic day for the Greek economy.

He’s right. It’s no exaggeration. It’s an outright lie!

What’s historic about the 15th rescue?

And as soon as the Greeks are fished out of the water, they’re to be given a shave and a haircut. No kidding. They’re supposed to shave off more public employees, more spending, and more benefits.

Already, one of 5 people is out of a job…with 2 out of 5 unemployed among young people. In November alone, 126,000 Greeks lost their jobs — the equivalent of 3.5 million job losses in the US, in a single month.

But the Greeks aren’t the only ones who are suffering. Their creditors are supposed to suffer a $100 billion haircut, too. Sounds like a default to us.

And what’s important about Greece’s 6th major default on its foreign debt? It defaulted for the first time in 1827. Since then, it’s made a habit of it.

The important thing, from our point of view, is that the Europeans are de-leveraging…getting rid of debt — at least a little, around the periphery of Europe.

Trouble is, there’s a whole lot more. And the level of debt, generally, is still increasing — thanks to the very same officials who just cut the latest Greek deal.

Here is where the numbers get a little unreliable. No, heck, they’re totally unreliable. But at least they give us a sense of the scale of the problem.

If you have debt equal to 100% of your income you can probably handle it. If the interest rate is 5%, you devote one twentieth of your revenue to debt service.

But if your debt goes to 200% of your income, the burden of the past begins to weigh on the future. You have to cut spending and investing, because so much of your income must be used to pay for things that have already been produced and consumed. Growth slows. The economy groans.

At 5% interest, you’d have to devote a full 10% of your income just to pay the interest. At 10%, you’re in real trouble…with one of every 5 dollars already spoken for, even before you get it.

The world produces about $50 trillion worth of output per year. Some countries — usually poor ones — have very little debt, for the simple reason that no one would lend them money. Others — such as the UK and the Netherlands — have total debt burdens over 500% of GDP. (Much of it is mortgage debt, which is a special case…since it may be considered an on-going expense, a substitute for rent.)

Even at 200% of GDP, debt doesn’t have to be a permanent and irreducible drag. If the economy grows faster than the debt, the burden becomes lighter over time. That is what happened in the US, for example, after WWII…and again, during the Clinton years.

The problem now — grosso modo — is that the growth is in the countries with little debt…and the debt is in the countries with little growth. In the US, for example, debt increases two to three times faster than GDP.

Most of the developed world is not so different from Greece. Some have more debt. Some have less. Overall, they have government debt equal to 100% of GDP. Household debt adds another 200% of GDP…or more; the typical developed country has total debt somewhere around 300% of GDP.

Total GDP is about $40 trillion. So in order to get total debt even down to 2 times GDP they need to wipe out $40 trillion of debt.

A long way to go…a tough row to hoe…

Austerity comes to the USA?

Not exactly. But The Wall Street Journal reports that taxes are set to go up:

First, the top marginal personal tax rate rises to 39.6% from 35% as the Bush tax cuts expire at the end of 2012.

Second, a limit on itemized deductions will add a further 1.2 percentage points to the top rate.

Third, a new 0.9% Medicare tax on incomes over $200,000 gets imposed ($250,000 for joint filers).

Fourth, the top 15% rate on long-term capital gains rises to 20%.

Fifth, dividends will once again be taxed at ordinary rates — 39.6% for the top income earners.

Sixth, a new 3.8% tax on investment income gets introduced for incomes over $200,000 ($250,000 for joint filers).

Seventh, the top estate tax rate goes from 35% to 55% (60% in some cases).

The estate tax exemption falls to $1 million from $5 million (the gift-tax exemption also drops to $1 million and the rate adjusts hither to 55%).

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