By Patrick A. Heller
Commentary on Precious Metals Prepared for CoinWeek.com

In past commentaries, I have discussed many of the accounting and financial sleight-of-hand gimmicks used by the US government in order to paint a rosier picture of federal finances. When doing so, I tried to give specific references and sources so that readers could double check my information. While I have received numerous compliments on such articles, there is a minority who apparently believe that when I quote data from the Federal Reserve, US Department of Labor Bureau of Labor Statistics, and similar sources that I am an extremist who should be ignored.

Today, let me try to explain the financial condition of the US government in the most favorable light, relying almost exclusively on data from the Congressional Budget Office (CBO).

In projections released last year, using only the overly optimistic cash flow basis of accounting used by the federal government instead of the more accurate accrual basis, the CBO projects that the current spending of the US government will rise from 23% of Gross Domestic Product (GDP) to more than 35% by the year 2035. At the same time, revenues and tax collections will rise to a bit over 19% of GDP by 2014 and level off there. As a result, the federal budget deficit is projected to rise from about 4% of GDP in 2014 to almost 16% of GDP by 2035!

There are two scenarios for trying to manage this economy-destroying rise in the annual budget deficit that are being promoted in Washington. The first is to do nothing except inflate the money supply. The problem with this is that it will inevitably result in soaring consumer prices. As repeated past experience in the US and other countries has demonstrated, high inflation of the money supply results in destroying the income and wealth of working people and retirees.

The second scenario is to raise taxes. As of yet, no politicians are yet willing to reveal just how high taxes would have to rise to cover the projected cash flow deficits, but the CBO has spelled it out. The lowest personal income tax bracket of 10% would have to rise to 19% by 2050 and 25% by the year 2082. The middle bracket tax rate would increase from the current 25% to 47% by 2050 and all the way up to 63% in 2082. The top income tax bracket would rise from 35% today to 66% in 2050 and soar to 88% in 2082. The corporate income tax rate would also rise from 35% now to 66% in 2050 and 88% in 2082. Keep in mind that these are only federal income taxes. Collections of state and local taxes are on top of these rates.

I think most people would agree that when federal, state, and local taxes approach 100% of income, that most people would lose the incentive to work to earn that income. Yet, in order for the optimistic CBO estimates to be achieved, people in current high income tax brackets must continue to work even when virtually their entire income is seized. Therefore, even as scary as the CBO projects might be, I think common sense tells us that the results will be much worse.

Stated simply, Uncle Sam is broke.

According to the White House Office of Management and Budget, federal spending in 2011 for Medicare, Medicaid, Social Security and other mandatory entitlement programs was projected to total $2.4 trillion. This consumed close to 100% of federal tax collections and revenues.

Last year, the August increase in the federal debt limit included a provision to establish a Congressional super-committee to come up with a token amount of spending reductions. This super-committee totally failed. Even in the middle of a crisis, Congress proved ineffective to accomplish any real spending reductions.

If you won’t believe me when I say that the US government is bankrupt, maybe you will believe the Congressional Budget Office or someone like David Walker (the US Comptroller General from 1998 to 2008) when they say the same thing.

You may close your eyes, ears, and minds because you don’t want to consider the implications of the US government’s financial mismanagement. But ignorance or wishful thinking will not make the problem go away. Instead, you owe it to yourself, your loved ones, and others to take a sober look at reality. Then prepare yourself. In my thinking, owning physical gold and silver is part of the solution.

Patrick A. Heller owns Liberty Coin Service and Premier Coins & Collectibles in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Numismaster (http://www.numismaster.com under “News & Articles). His award-winning radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.

By Patrick A. Heller
Commentary on Precious Metals Prepared for CoinWeek.com

In my last column I warned readers that the default of Greek sovereign debt can happen much sooner than the politicians admit. If (I really mean “when”) this crisis hits, what is likely to occur will almost certainly result in the bankruptcy of major US banks. Here’s how.

When the Greek sovereign debt defaults, I fully expect the US Treasury and Federal Reserve to do everything possible to shore up global finances. I’m sure this would include a combination of publicly disclosed tactics meant to reassure the public and also behind the scenes moves that would scare people if they became widely known. In this process, it would not surprise me to see the US government spend hundreds of billions to trillions of dollars.

Unfortunately, the US government simply does not have enough resources to manage every problem.

For instance, credit default swaps (CDS) are currently a $32 trillion market. That is double the size of the US Gross Domestic Product. It is also about double the size of the “official” national debt.

Credit default swaps are a derivative taken out by investors as insurance against defaults in the repayment of loans. According to the US Comptroller of the Currency, nearly 95% of the banking industry’s exposure to derivatives contracts is held by five of the largest US banks: JPMorgan Chase, Citigroup, Bank of America, HSBC, and Goldman Sachs.

Credit default swaps are unregulated. There is no requirement that the sellers of these derivatives have the financial ability to pay to cover losses on debt defaults. But, the risks are even worse than these two loopholes.

Whether a failure of a debtor to make a required payment constitutes a default requiring a payment on a credit default swap is determined by the International Swaps and Derivatives Association (ISDA). Guess what, the ISDA is owned by the world’s largest banks and hedge funds. That means that the banks that would be required to make payments on credit default swaps are also the institutions that decide whether payments are required.

The MF Global bankruptcy last October was triggered by credit default swap losses. MF Global was a major derivatives broker, leveraging its exposure at least 40 to 1. Because of the extreme leverage, the derivative losses on $6.3 billion of some shaky European debt pushed the company into bankruptcy.

In theory, MF Global owned credit default swaps which should have covered the losses. But the ISDA declared that the decline of European debt, as much as 50% of face value in some circumstances, was not a default. Therefore, the MF Global’s counterparties on the credit default swaps did not have to pay up, guaranteeing the failure of the company.

The failure to collect on credit default swaps in the MF Global bankruptcy has shaken confidence in the entire market for derivatives. In other words, when investors see that MF Global was unable to collect on their credit default swaps, they will tend to refuse to purchase such derivatives. Although the five major US banks don’t want to admit it, a major percentage of their recent operating profits have come from the sales of derivatives such as credit default swaps. If these banks don’t pay up for their liability in the default on Greek sovereign debt, they will lose billions of dollars in future profits.

It is not surprising that mega-billionaire investor Warren Buffett declared derivatives to be “weapons of financial mass destruction.”

Even if the US government could print enough Federal Reserve Notes and issue enough Treasury debt to prevent the failure of these five banks, the result of this hyperinflation of the money supply would destroy the US dollar.

Although the immediate financial system looks set to collapse, that is not necessarily all bad news. That would be a great opportunity to re-introduce a stable monetary system that politicians could not manipulate—such as physical gold and silver.

Patrick A. Heller owns Liberty Coin Service and Premier Coins & Collectibles in Lansing, Michigan and writes Liberty’s Outlook, a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Other commentaries are available at Numismaster (http://www.numismaster.com under “News & Articles). His award-winning radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.