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Aug. 11 (Bloomberg) — Laurence Kotlikoff, an economics professor at Boston University, talks about the state of the U.S. economy. Kotlikoff speaks with Erik Schatzker on Bloomberg Television’s InsideTrack.” (Source: Bloomberg)

Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.

What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.

Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.

Is the IMF bonkers?

No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

‘Unofficial’ Liabilities

Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.

For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.

The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

$4 Trillion Bill

How can the fiscal gap be so enormous?

Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.

This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: “Something that can’t go on, will stop.” True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.

And it will stop in a very nasty manner. The 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.

Worse Than Greece

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.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.

Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.

My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”

(Laurence J. Kotlikoff is a professor of economics at Boston University and author of “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking.” The opinions expressed are his own.)

To contact the writer of this column: Laurence Kotlikoff at kotlikoff@bu.edu

Is the US in worst economic shape than we think and if so, what will it take to get a real recovery?

Good to know but also worries me about how all this could rebound in the next decade.

High Frequency Swanning – The Crash Camp Takes Over

• Joshua M Brown
• May 18th, 2010

Here a Swan, there a Swan, everywhere a Black Swan…

Newsletter writers, hedge fund managers, journalists, bloggers, technicians, fundamental analysts, economists and strategists are joining the crash camp left and right.  Not the bear camp…the crash camp.

I’ve been running around Manhattan all day taking care of business, meeting clients etc.  After scanning today’s articles and blog posts, I can honestly say that I’ve never heard more chatter about an imminent market crash, all at once, in my life.  It’s like the May 6th Flash Crash got everyone in the mood to talk cataclysm all of a sudden.

I’m not one of those guys who takes everything as a contrarian signal.  I abhor knee-jerk contrarianism.  Samuel Lord once said “Do not choose to be wrong for the sake of being different,” and I think that’s kind of apropos here.

As avowed contrarian Dougie Kass likes to remind us, the crowd usually outsmarts the remnant when herd mentality takes over.  So what is the herd hearing/ seeing?

* First of all, the macro guys are disturbed by the Euro Zone’s crisis and its ripple effect/ contagion risk.  This isn’t new but it is more pervasive.  And the possibility of a China collapse scares the hell out of almost everyone.

* The technicians and Dow Theorists are grossed out and have dusted off all the 1937 charts again.  Specifically, they are looking at the highly distinct pattern of a big drop (May 6th) followed by a failed rally (euro bailout day’s 4% gap open) followed by another fast sell-off.  Richard Russell‘s latest missive, in which he tells us that we won’t recognize America by year’s end, will make you want to kill yourself.

* Equity analysts are all pointing to year-over-year comps which will start getting harder now.  They may feel OK about the “E” but they’re shaky about the “P” – will the tax hikes and regulatory headwinds we now face really allow for a high-teens multiple on whatever the earnings turn out to be?

* Bond guys are freaking out about sovereign stuff, obviously.  We’ve transferred corporate risks onto government balance sheets with bailouts, the Piper still awaits his payment in many cases.

* Eddie Elfenbein posted the results of a CNBC poll yesterday in which 40% of respondents predicted a 50% haircut for the Dow.  Seriously, almost half the respondents predicted Dow 5000 by the end of this year.

* The hedgies are vocally bearish again as well.  Seth Klarman‘s got some cautious commentary out today and Jeremy Grantham‘s “sell everything” stuff is being quoted everywhere.  Raoul Pal put out a newsletter this week with a 2 day-to-2 week crash prediction.

We’re not talking garden variety bearishness here.  We’re talking about ubiquitous crash predictions.  My comment is that I’ve never seen so much certainty in so many places of a coming crash.  Will it be self-fulfilling or are we talking major contrarian signal?

Worth noting no matter what.

Full Disclosure: Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities, please see my Terms & Conditions page for a full disclaimer.

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Tahoe 10 hours ago

1 person liked this.

hey Josh. most excellent work as always. This one had me chuckling at

“Richard Russell’s latest missive, in which he tells us that we won’t recognize America by year’s end, will make you want to kill yourself”

With such strong vocals on crashing isn’t that when it will do exactly the opposite and place the hydraulic vice on the bears head once again? Don’t get me wrong, I am of the belief that there remains significant downside coming – timing being the key – but I cannot get past the mountainous debt across the globe, the complete lack of any reasonable and practical debt-credit-value relationship.

Keep up the awesome work! Tomorrow is another trading day.

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tamelarich 20 minutes ago

I’m a fan of Buddhist monk Pema Chodron’s book “When Things Fall Apart” and think her work provides a useful frame of reference for the dread we feel about the changes now upon us. “We think that the point is to pass the test or to overcome the problem, but the truth is that things don’t really get solved. They come together and they fall apart. Then they come together again and fall apart again.”

Things fell apart during the Depression, so we implemented entitlement programs and erected new regulatory bodies. Things came together. I argue that the only reason we’re not in another Great Depression today is the post-Depression social safety nets that now provide unemployment insurance and a baseline of health insurance to our elderly and most financially vulnerable citizens. But since we essentially dismantled Glass-Steagall, and financial mathematicians developed products that were unforeseen by jazz era regulators anyway, we produced fake wealth and things fell apart again.

When we can accept the falling apart and coming together of all things in life, we can look at the work before us as an opportunity to build something stronger and better for the next iteration — until it inevitably falls apart again.

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danandreas 11 hours ago

great article! Taleb’s are surfacing all over the world! if our market does take a 5000 haircut i wouldn’t be surprised, but i’m not trading that way yet. it looks like our dollar has a long way to fall and cushion a crash or correction. we’ve yet to really experience inflation other than, in my opinion, production, quality and human resources. when our dollar starts reacting and losing value globally, and in relation to euro dollar recovery, then there may be more potential for the great black swan. for now our dollar is a big preinflated air bag. even if we crash because we can’t see(perhaps our navigator fell asleep) its not going hurt much
http://finviz.com/futures_charts.ashx?t=DX&p=w1

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reformedbroker 10 hours ago in reply to danandreas

interesting take, thx dan

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Dave Pinsen 11 hours ago

The best time to buy crash insurance is before the crash predictions become ubiquitous.

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Good read… I’m not quite as fatalistic but I do feel there could be another serious correction in the near future.

NEW YORK (MarketWatch)– Shares of Wall Street investment banking giant Morgan Stanley /quotes/comstock/13*!ms/quotes/nls/ms (MS 27.00, -1.38, -4.85%) fell about 4% on Wednesday morning after the Wall Street Journal reported that federal prosecutors are conducting a preliminary investigation of the firm’s mortgage trading business. Morgan Stanley told the paper is has not been contacted by the government regarding a probe, and its Chief Executive James Gorman reiterated that point at a press conference on Wednesday in Tokyo, the paper said. Morgan Stanley shares fell 3.98% to $28.38 in preopen trading.

After GS, it’s MS’ turn to go under the microscope.