Casey Files:
Government Debt - Termites in the House

The Casey Files
By Bud Conrad for Casey Research
The International Speculator
Jul 3, 2006

As I write, gold has rebounded handsomely over the $600 mark, perhaps putting a stake through the heart of the recent steep correction.

Or, perhaps not.

After all, it isn't the fundamentals, per se, that are currently causing gold to spike. It's largely just the chattering of the trading community based on their reading of the tea leaves revealed in the Fed's latest press release.

In order to make any real sense of where gold should be trading, and will be trading soon enough, you have to look deeper, much deeper, into the entrails of government spending. And few people are better at that than Bud Conrad, a senior researcher here at Casey Research.

Bud, who sports a degree from Yale and an MBA from Harvard, spends more time than any person I know looking intently under the hood at the hard data to take measure of the real state of the economy.

Bud recently had lunch with David M. Walker, head of the U.S. Government Accountability Office (GAO) and then followed up with him on the outlook for the U.S. economy, especially as it relates to deficit spending.

His report follows, below. It's important. Read it. Pass it along.

Doug Casey
Chairman, Casey Research, LLC.

Editor, The International Speculator

Government Debt: Termites in the House

By Bud Conrad

Recently I had the pleasure of having lunch with the Comptroller General of the United States, David M. Walker. He heads up the U.S. Government Accountability Office (GAO), the government's internal watchdog. As he was about to give a talk on out-of-control government deficits, he had in his briefcase a chart on the size of the government's obligations over time. Our discussion about those obligations over lunch was followed by an email exchange, and Walker kindly helped me source additional GAO data, all of which allowed me to confirm my analysis of the budget with projections from the Congressional Budget Office (CBO).

I have also met with Douglas Holtz-Eakin, head of CBO, who can competently recite the situation of six different budget projections without notes. The combined scenarios of the GAO and CBO provided me with the basis to create the following projection of the U.S. budget:

A clear picture emerges of a government completely out of control. The blue line is the history of the U.S. Federal Government debt. The green line shows the path we are now on, with debt soaring to impossible levels against projected GDP. Importantly, the source isn't some crazy hand-waving blogger: these are the government's own projections-and we all know they have every incentive to accent the positive. If this is the best they can do at this point, then you know things are not just bad, they are calamitous.

This glimpse at the future clearly shows that the debt of the U.S. will, in the foreseeable future, go from being a troubling yet manageable fraction of the economy to being several times the size of economy. That can't happen without serious repercussions.

The government will be spending money they don't have, which means creating more of it out of thin air and diluting the value of all the dollars that came before. It doesn't take a Harvard MBA to know that the kind of deficits projected above guarantee a persistently weak dollar, higher inflation and higher interest rates going forward.

You may be right to criticize this analysis as only one of many scenarios being developed all the time and that there are other assumptions that lead to other estimates, and you would be right.

But I've looked at the assumptions, as has David Walker, and it is more likely that the assumptions have underestimated how serious the situation could become, maybe by a significant margin. For example, in the projections above, the interest rate paid by the government stays flat. Interest rates fell for 23 years and have only just recently bounced off of 45-year lows. The odds of interest rates staying at these low levels for decades into the future are, in my opinion, nil. I have analyzed the scenario of the impact of higher interest rates. The problem can get out of hand because it feeds on itself: higher interest rates lead to higher interest on debt, which leads to higher debt, which leads to greater loss in confidence in the dollar, which leads to higher interest rates and the loop makes itself worse.

The Blame

Who is responsible for this sin of profligate spending? You could start by pointing a finger at the House of Representatives as they are constitutionally charged with holding the purse strings of the U.S. government. They voted for the spending and programs we are now saddled with, they pass tax programs, and vote in the big supplemental bills that fund the wars.

Entrusted with allocating the biggest sums of funding in the world, they clamor for more and, in the process, act like termites chewing away at the fiscal underpinnings of the economy, assuring the future bankruptcy of the nation. And it is not just the modern politicos that are responsible, but a failure to pursue sound monetary policies that extends back decades. Why do they do it? That answer is easy and reflective of human nature they do it to curry favor with their constituents in order to get reelected.

Which further points the finger at us, the American public, who instead of voting the bums out for wasting our money and handing a legacy of debt to our grandchildren's grandchildren, happily pocket the pork belly doled out and reward the most prolific spenders with our votes.

The bottom line is that debt and deficits are baked into the cake, exacerbated by the demographics of retiring baby boomers and a government that not only shows no intention of slowing its spending, but quite the opposite. In fact, like a penniless smoker breaking a child's piggy bank to buy a pack, the debt-addicted government has already spent the supposed "Trust Funds" of Social Security and Medicare.

The government is closer to bankruptcy than anyone who has not studied the situation can guess. You will hear government apologists claim that the government can't go bankrupt because they are the government, and along with a complicit Federal Reserve, they can meet any debt obligation because they have the printing press. That is precisely the problem. They can print any amount of money they want. That has been theoretically possible since we went off the gold standard in 1971.

It is this loss of any constraint on government spending that has let the genie out of the bottle. The track is now laid. The long-term future of the dollar is not in question. And to the extent that it is the basis of all other currencies, the reserve currency of the world's central banks, all currencies are doomed.

Gold and the quality companies that produce or competently explore for it (our focus in the International Speculator) should no longer be viewed as entertaining speculations, but as portfolio requisites.

AUTHOR BIO:
Bud Conrad holds a Bachelor of Engineering degree from Yale and an MBA from Harvard. He has held positions with IBM, CDC, Amdahl, and Tandem. Currently, he serves as a local board member of the National Association of Business Economics and teaches graduate courses in investing at Golden Gate University. Mr. Conrad, a futures investor for 25 years and a full-time investor for a decade, is also a regular lecturer for American Association of Individual Investors. As a senior researcher for Casey Research, LLC., he produces original research and analysis for the International Speculator.

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