Monday, March 19, 2018

James Turk: Bankruptcy 1995 Revisited

In 1992 a book entitled “Bankruptcy 1995: The Coming Collapse of America and How to Stop It” hit the nation by storm. Written by Harry Figgie, a prominent businessman who had built a Fortune 500 company, and Gerald Swanson, an economics professor with expertise in public finance, it forecast that the US federal government would go bankrupt in 1995 and default.

The default would arise from a currency[i] collapse. Each lender to the federal government might receive back the same number of dollars they had loaned, but those dollars would have considerably less purchasing power[ii], and possibly none at all, making them worthless. So US Treasury debt instruments would have little or no value because they are denominated in dollars, the purchasing power of which would be decimated by hyperinflation.

Obviously it hasn’t happened. Even though the dollar subsequently experienced some horrific swoons and its purchasing power continues to erode, it has endured, but we should not ignore this book’s conclusions.

Two Key Assumptions Underlying “Bankruptcy 1995”

The logic of the authors’ analysis was faultless, but it was built on two assumptions, one of which turned out to be wrong. The first correctly inferred that the federal government’s debt would continue to increase, which at the time they wrote it had done every year since 1969. This ignominious annual streak of new indebtedness remains unbroken to this day.

The incorrect assumption was that interest rates would remain high and even increase. This interest rate outcome would occur because of the federal government’s growing debt load. The authors naturally expected that lenders would require higher interest rates to compensate them as the risk of default grew as a direct result of the growing debt burden.

The authors did not, however, anticipate that the Federal Reserve would force interest rates to unnaturally low levels. They did not – nor did anyone else – expect to endure what we now call “financial repression”, but forcing interest rates lower was only part of the repression.

The federal government also had to convince the purchasers who bought its debt that everyone was getting a fair deal. In other words, not only did the federal government need to lower interest rates, it needed to make the inflation rate look low too.[iii] In this way, real interest rates – the nominal interest rate less the purported inflation rate – would show a positive return to the lender. After all, lenders expect as a matter of course to gain purchasing power when lending their dollars to compensate them for putting them at risk while foregoing until the future the purchasing power it represents.

Clearly, it was going to be a Herculean task to convince lenders – and indeed, the ‘market’ – that inflation was not as bad as people were experiencing from their everyday purchases. But it was a task that had to be undertaken to postpone the projected 1995 bankruptcy and currency collapse.

So the federal government formed the “Advisory Commission to Study the Consumer Price Index”. It of course concluded that inflation was not as bad as everyone believed. Even though the federal government in the early 1980s had already changed the calculation of the CPI to report an inflation rate that was lower than the true rate at which the purchasing power of the dollar was being eroded, it did so again[iv].

This pernicious sleight of hand by the government significantly distorted the means to perform accurate economic calculation with the result that for decades, precious accumulated capital earned from hard work has been misallocated and wasted on countless follies. What’s more, currency debasement has taken purchasing power out of the hands of savers and diminished the value of one’s wages. Even if the amount of the wage increased, “keeping up with inflation” requires cost of living adjustments above the CPI. [v]

The federal government’s fiddling with its calculation of the dollar’s inflation rate is without a doubt the biggest swindle of all-time. The result has been increasing friction across the US and throughout all levels of society. As Lenin correctly observed, to destroy society you simply debauch the currency.[vi]

I have presented this background information purposefully in order to ask the following question. What if “Bankruptcy 1995” was written twenty-five years too early?

- Source, James Turk