A debtor government cannot afford deflation

Our government owes trillions of dollars (or, in smaller numbers, Thousands of billions of dollars). What's more, our government has committed to fund tens of Trillions of dollars in government and military pensions, Social Security, Medicare, and similar programs. Although there is no promissory note on these additional liabilities, they are owed just as sure as the cash your children are expecting for their next birthday. And our debt grows every year now.

Well, heck, we all know there's a lot of government debt, but what do we really care?

We care a lot - because the debt ties the government's hands. We pay a huge amount of money in interest on $10 Trillion dollars (figure $400 Billion in interest at 4%). In order to maintain that kind of debt, long-term, we need somebody to keep lending to us. Right now, there are a lot of foreign individuals and governments that are happy to fund our debt addiction. But we have to be careful to keep them happy, to keep them lending. Could part of our bailout/rescue plan be a "Keep the Chinese confident in American bonds so they keep lending us money" plan? I don't know, but there is certainly a risk that, when we hit $20 Trillion in debt to pay some of those pension obligations, lenders cut us off. That's a mighty scary scenario.

In the meantime, the debt ties the government's hands in dealing with the current crisis. If the government lets the market tank, we risk a deflationary spiral. If we have a deflationary spiral, corporate, personal and investment incomes could decline. If incomes decline, the government's tax revenues on that income will decline, too. If government revenues decline, the government's debt will not decline. Less income to pay the same debt = major pain. Either the government has to cut back (a lot) or the government has to try to keep the debt afloat until incomes rise again.

Now, we're back to the Chinese (and other foreign nations) again. Think about this - the government, in a deflationary situation, is like a CEO with a mortgage. He gets laid off, manages to find an embarassing job doing business development for a much smaller company for a much smaller salary (but he's got a job, thank goodness) - and his mortgage is suddenly huge in comparison to his income. Our CEO is suddenly a bad credit risk - he whips out his AmEx Gold card to buy a tank of gas, and it's denied. He charges the gas to his visa card, and finds out they've jacked his interest rate to 29%. Government borrowing is a bit more complex, but it's still the same basic idea - high debt-to-income rations equal higher interest rates, and some lenders just won't lend to you anymore.

The government currently spends a bit shy of $3 Trillion, with almost a $1 Trillion shortfall every year (and that shortfall gets borrowed, and added to our total debt). The government is taking in, roughly, $2 Trillion a year in an economy where the total GDP (total of everyone's income) is about $13 Trillion. Suppose GDP fell by 10%. Government revenues would probably fall about 10%, too. If a lot of people are laid off, the government could take a bigger hit (individual income taxes are a higher percent than corporate or investment income taxes) - AND more people would ask for government services (food stamps, welfare, etc.) because they can't find jobs. The government gets hit with a double whammy - lower income, higher expenses. The government's "credit rating" drops instantly.

The government is stuck between a rock and a hard place.

If they cut expenses to balance the budget, the economy will slow even more. If the economy slows more, incomes drop more, and income tax revenues drop more. The relative value of the debt becomes larger in comparison to tax revenues. Interest rates rise to reflect our declining credit-worthiness, raising expenses, requiring further cuts, further slowing the economy. Social security and pension payouts become more attractive compared to private sector employment income, and people retire earlier.

If they keep borrowing and spending, inflation will rise and their credit rating will fall and the value of the dollar will fall even more than it already has. If the value of the dollar falls, the price of oil rises, and the American public gets squeezed even harder between falling wealth and rising prices. And the government, paying to fuel everything from government vehicles to military tankers, gets squeezed, too. But, the silver lining is that the debt begins to look smaller in comparison to the inflation-swollen tax revenues. The downside, however, is that the falling dollar decimates the value of foreign investment in American debt. If a foreign investor is losing money on the exchange rate, lending us money becomes a bad investment.

When this is all said and done, I hope that the lesson future generations take away is "never, ever, ever let government debt get so high." But, for current generations, we are in an ugly, ugly place. Bottom line: I expect much higher taxes in the future, and probably for the rest of my lifetime. Priority 1 needs to be: Get things situated so we can pay down debt. Priority 2: Pay down debt. We will pay for this, one way or another. I would rather pay a little more tax today (to reduce the debt) than pay the interest over and over and over again.

(Many voters are confused about the fact the the Clinton administration left the Bush administration with a surplus. The Clinton administration left behind a mountain of debt, but with a budget that allowed surplus funds to begin whittling the debt down. Bush didn't run up the whole $10 Trillion in debt by himself. That's not to say that Bush is innocent, nor that Bush is to blame - we began borrowing from the Social Security trust fund during the Johnson administration, and every President since has continued us along this financially irresponsible path. Every Congress along the way - with ultimate power over the budget - has contributed to the mess. It is a bipartisan effort of the worst kind, and we voters should not tolerate any more partisan finger pointing.)