#2: The Story of Fred

I have a friend whom I have known all my life.  His name is Fred.  I don’t see Fred as much as I used to when we were younger.  However, we have established a tradition of getting together with our families every July 4th.  This year, as the wives were chatting and the kids were playing in the pool, Fred brought me a beer and opened up.  “You know, Jim, the career is going okay, but I’m just not getting ahead.  Know what I mean?”

“No, not exactly, Fred.  On the outside, it seems like you’ve got everything under control.  Are you having trouble financially?”

“Well, all the bills get paid, you know?  But every year I’ve got more and more debt.  I don’t know what to do.  I need your help, Jim.  Can we sit down together this weekend?  I want to go over my situation with you and get your feedback.”

“Sure.  I’ll come to your place this Saturday.  That way if you need any records, you should have the data right there.”

When I arrived at Fred’s house the next weekend, he invited me into his dining room, where he was clearly ready for me.  He had his documents neatly organized in piles and his laptop fired up.  “Thanks for coming, Jim.  I’ve been gathering my records since 2005.  Where do you want to start?”

“Well, Fred, you indicated to me on the 4th that your problem is you cannot get out of debt.  Let’s start by looking at your income and expenses.”

After a couple of hours of looking at Fred’s records from 2005 to 2015, I started to understand why Fred was having trouble managing his debt.  In 2005, Fred’s income was just under $65,000.  In 2015, his income had grown to just over $100,000.  Not bad!  He was getting average raises of 4.43% per year.

On the other hand, in 2005 his expenses were $69,300.  On top of that, he paid $4,460 in interest.  In order to cover this, he borrowed $8,780 from his parents.  Every year since 2005, the story was the same.  Expenses were greater than his income, his interest payments grew and he borrowed more money from his parents.  In 2015, Fred’s expenses were 108,980.  He paid his parents $16,760 in interest, but he borrowed $25,520 from them at the same time.

“Fred, do you parents understand that the interest you pay them is coming from the money they lend to you?”

“Yes, but they know I’m good for it.”  I just shook my head.

Here was the root of the problem.  The ratio of Fred’s expenses (including interest payments) to his income grew from 114% in 2005 to 125% in 2015.  Here is a picture of this trend.

Exp to Inc bar chart

 

The understandable result of this spending pattern was that Fred’s debt grew from $363,000 in 2005 to $540,200 in 2015.  This was an average increase of 4.06% per year.  The interesting thing is that his income to debt ratio was nearly constant at 18% to 19% per year.

This is why his parents let him borrow more money.  As his total debt grew, however, his parents expected him to pay a higher interest rate.  In 2005, he paid interest at the rate of less that 1.3% per year.  A sweetheart deal!  By 2015, however, he was paying his parents 3.25% per year.  This meant that while his income grew approximately 50% in 10 years, his interest payments nearly quadrupled.  Now I understood why Fred was feeling the pinch.  More money for interest payments meant less for other expenses.

“Fred, you owe your parents over half a million dollars now.  Do you have a plan to pay your parents back ever?”

“Well, no.  With my expenses, it’s just not possible.”

I did not want to judge Fred too harshly before understanding the meaning of his statement.  As we dug into the details of his expenses, I learned how incredibly generous Fred is.

In 2005, Fred gave his grandparents $17,640, or 27% of his income.  On top of this, he covered $10,800 of their medical bills, another 17% of his income.  This doesn’t include the $7,000 he gave to the poor to cover more medical bills, another 11% of his income.  This was a total of 55% of his income.  Every year, the percentage of his income that he gave to his grandparents and the poor increased a little more, so that by 2015, he gave away 63% of his income.  Clearly, he was borrowing money to cover his other expenses and pay interest on his debt.

“Why do you do this, Fred?”

“Well, I have to.  They have no other income.  If I don’t, they’ll die.  They supported my parents and me when I was growing up.  They’re entitled to live a decent life and get the medical care they need.”

**************

I’m interrupting this dialog to reveal to you that this entire story is a fiction.  I have no friend named Fred.  I created Fred and his financial situation to illustrate the values found in the Presidential 2017 Federal Budget Report on a scale that most people can understand.  All the numbers in Fred’s story are directly proportional to the expenses and resources in the federal budget.  I took the budget numbers expressed in $Billions and multiplied by 20 and created Fred’s budget in $1000’s.  For example:

$223 Billion x 20 = $4,460 (drop the “Billion).

Also, all the years in the federal budget I shifted to the past by 10 years to create Fred’s story.  The federal budget report starts in 2015 and looks forward to 2025.  Hence, the situation Fred finds himself in 2015 is what our government expects our nation will face 8 years from now.  In summary, this means

  1. The federal government expects to spending 20% to 25% more than it raises in taxes every year.
  2. The national debt in 2015 reached $18.15 trillion, about 101% of the US gross domestic product (GDP). This will grow approximately 4% per year to $27 Trillion by 2025.  Assuming average growth per year equal to 3.22% the ratio of national debt to US GDP will be 112%.  If growth stays low as recently reported in Q2, 2016, about 1.2% per year, the ratio of national debt to US GDP will balloon to 134%.  See chart below.
  3. Interest payments on the national debt will grow an average of 14.15% per year and quadruple by 2025 compared to 2015.
  4. By 2025, all entitlement programs will account for 80% of federal tax receipts, compared to 71% in 2015.

Nat Debt to US GDP

Given these forecasts, the following questions come to mind.

  1. How will our government operate under these conditions?
  2. What happens if interests go significantly higher?
  3. What will happen to the value of the US dollar?
  4. Would social chaos break out if the federal government stops sending out mandatory entitlement checks?
  5. What is the best way to change these predictions in order to maintain social order and avoid the breakdown of our constitutional government and way of life?

In future posts, I’ll be looking at the components of the federal budget in greater detail, but still digestible to the average person.  I will also present at least four alternatives which arrest the growth in the national debt.  In three of these alternatives, I will show that it is possible to actually start to pay off the national debt.  Of course, each scenario has implications for the amount of spending in both mandatory and appropriated categories.  These are the choices made by politicians.  At least for now, we elect the politicians.  Ultimately, the choices and responsibility for our future still depends on we, the people.

Before you go to the next post, an interesting website to visit is the US Debt Clock.  This is a fascinating display of real-time figures related to not only the U.S. national debt, federal budget items, tax revenues, etc., but also includes state and world debt clocks.  Did you know Mr. or Ms. Taxpayer, that as of this writing, your personal share of the U.S. national debt is just over $162,000?

US Debt Clock

 

 

 

 

 

 

 

 

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