The truth Obama didn't tell his party: The US is broke

When Manmohan Singh speaks he puts us to sleep.

When Barack Obama speaks, the world listens. In his speech to accept the Democratic Party’s nomination to run for his second term as President, Obama touched all the right chords. The speech had the right amount of nostalgia, advise, self-marketing and hope built into it.

His vision of the future, as is the case with anyone asking for votes in a democracy, was optimistic, without getting into the specifics. The American dream is still on, despite the difficulties the country has faced over the last five years due to the financial crisis. That was the takeaway one got from Obama’s speech.

“But as I stand here tonight, I have never been more hopeful about America. Not because I think I have all the answers. Not because I’m nave about the magnitude of our challenges. I’m hopeful because of you,” said Obama

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While hope is a good thing to have, at times we need to ignore the mess we are in, in order to have some hope. And that precisely is my problem with Obama’s speech. There was a lot that he should have said, but did not.

[caption id=“attachment_448722” align=“alignleft” width=“380”]  The biggest problem in America today is not unemployment or slow economic growth but the unfunded liabilities like pensions, social security and medical care benefits that the government has promised to the citizens. AP[/caption]

The biggest problem in America today is not unemployment or slow economic growth but the unfunded liabilities like pensions, social security and medical care benefits that the government has promised to the citizens.

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As economist Laurence Kotikoff wrote in a recent column: “The 78 million-strong baby boom generation is starting to retire in droves. On average, each retiring boomer can expect to receive roughly $35,000, adjusted for inflation, in Social Security, Medicare, and Medicaid benefits. Multiply $35,000 by 78 million pairs of outstretched hands and you get close to $3 trillion per year in costs. This is not a partisan issue. The dirty little secret that neither President Obama nor Mitt Romney is telling you is that our kids, who are being stuck with the bill, can’t afford it.”

The $3 trillion that Kotlikoff is talking about is a lot of money. The current American yearly GDP is $15trillion. Hence, the costs Kotlikoff is talking about amount to nearly 20 percent of the annual American GDP. And it is unfunded.

Before we go further let’s try and understand what unfunded liabilities are. Let us say I plan to retire 10 years from now. I feel that Rs 16 lakh per year should be enough for me to sail through the year. But to earn that Rs 16 lakh I would need to build a corpus of Rs 2 crore in 10 years’ time, and assuming that I am able to earn an interest of 8 percent on this corpus, 10 years from now (8 percent of Rs 2 crore works out to Rs 16 lakh).

In order to build a corpus of Rs 2 crore in 10 years’ time I will have to start saving and investing money regularly from now. If I don’t I will be in trouble 10 years from now. Either I won’t be able to retire or if I retire I will have to borrow to meet my expenses.

The same logic, at a very basic level, works for governments as well. The government gives a pension to people when they retire. If a certain number of people are expected to retire 10 years from now, then they would have to be paid a certain amount of pension. While estimating the exact amount is difficult, estimates can be made. But what we know for sure is that money is to be saved now so that citizens can be paid pensions later.

If governments don’t invest the right amount from now on, which a lot of them don’t, including the US government, they will have to pay these citizens by borrowing money later. And if pensions and other commitments made to the citizens cannot be funded through the investments already made, they are said to be ‘unfunded’.

Mitch Feierstein, in his book Ponzi Power - How Politicians and Bankers Stole Your Future, writes: “Using proper accounting methods…the true value of the state and municipal pension liability is at $5.2 trilion. When you deduct the $ 1.94trillion of pension assets that have already been set aside, you get a net liability of $3.26 trillion.”

Other than this, the US government already has an existing debt of around $15 trillion. Feierstein also points out that the social security programme of the US government is underfunded to the extent of $18.8 trillion. The underfunding in Medicare, the health insurance programme, amounts to around $38.5 trillion. So if you add all of this up the number comes to greater than $75 trillion and that is what Feierstein feels the US government owes to other governments and its own citizens.

And that’s just one estimate and a very conservative one. Kotlikoff’s estimate is scarier. As he wrote in a recent column, “I recently calculated the fiscal gap…The fiscal gap measures the present value difference between all projected future federal expenditures (including servicing official debt) and all projected future taxes. The fiscal gap is thus the true measure of our government’s total indebtedness and the true measure of fiscal sustainability. How big is the fiscal gap? Brace yourself. It’s $222 trillion large!… In short, our government is totally broke. And it’s not broke in 30 years or in 20 years or in 10 years. It’s broke today.”

So how large is $222 trillion? The annual GDP of the whole world is around $60 trillion. The GDP of the United States of America is around $15 trillion.

So what is the way out of this? “Here’s one way to wrap your head around our $222 trillion fiscal hole: closing it via tax hikes would require an immediate and permanent 64 percent increase in all federal taxes. Alternatively, the government could cut all transfer payments, e.g. Social Security benefits, and discretionary federal expenditures, e.g., defence expenditures, by 40 percent. Waiting to raise taxes or cut spending makes these figures worse,” writes Kotlikoff.

Another way out for the American government is to print money to meet its expenses (something which is it is already doing). As Kotlikoff puts it another column, “T_he first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills. Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece._”

If America has to get out of this hole, the American way of life has to change. And that as Obama’s speech clearly points out is unlikely to happen.

Vivek Kaul is a writer. He can be reached at vivek.kaul@gmail.com