Are We Broke? Part I of Series

March 15, 2010
By John

Over the next couple of weeks, Rough Truths will publish a series of columns that address the question “Are We Broke?”

There is much talk in political, economic and banking circles about whether we are on a path to insolvency, what the debt means for the tax rates we will pay, what the implications are for work and wages, and what the future of interest rates might be.  All of these are good questions – but the Rough Truth question is whether we are already broke, and whether there is a path is out of this mess.

The series will be organized into topics that will walk the reader through a discussion of the concept of national insolvency, the value of our assets, and the extent of our debts.  We will also discuss the obvious and painful solutions we must accept to escape this tsunami of our own making, and our likely disintegration as a nation-state should we fail to do so.  We will start with the first bullet below today, and then tackle the others in sequence.

  • Why should we worry (now)?
  • What does it mean to be broke?
  • But aren’t we the richest nation in history?
  • How much do we actually owe?
  • What can we do?

Why Should We Worry (Now)?

A lot folks are wondering – how did this happen so quickly?  Haven’t we been hearing about a looming debt crisis for a few decades?  It didn’t seem to matter before – so why should I care now?

The truth is we have been using our balance sheet to achieve policy goals with debt since our founding – for different and often good reasons.

  • Alexander Hamilton, our first Treasury Secretary, argued persuasively that some amount of national debt would make international lenders and foreign powers take America seriously as a new nation – and would enable our nascent financial markets to develop.  He was right.
  • Andrew Jackson argued that the Bank of the United States was a corrupt, crony-led institution that the elites used to keep the average American down and enrich themselves.  He also argued that a fast growing, industrializing, export-centric, continental nation shouldn’t issue debt.  So he killed the bank and paid off the debt.  He was also right.
  • The Federal Reserve was created in 1913 (nominally) to mitigate the periodic boom-bust cycles emanating from Wall Street, and (theoretically) to protect depositors from resulting bank runs.  Neither of those things happened, unfortunately.  But it also created a magic printing press, and has allowed the Federal Government to run a string of debt-funded spending binges with little challenge ever since.

Federal Debt as % of GDP (1800-1999)

  • During the Reagan years, a combination of income tax cuts and defense spending increases temporarily raised the annual budget deficit to a peak of 6.5% of GDP, but the resulting rapid economic growth and relative austerity in other areas soon eased the annual debt back to a ‘normal’ 2-3% of GDP by the time he left office.
  • During the Clinton years, the end of the cold war and moderate fiscal/monetary policies combined to reduce annual deficits, and begin a modest pay-down of debt.
  • And during the Bush Administration – which faced its own near-calamity on taking office with a recession, a scandal-driven Wall Street crash, and the 9/11 attacks – ran up annual deficits of as much as 3-4% of GDP at their peak.  But we saw them ease back to less than 1.5% of GDP ($161 billion) in 2007 before the 2008 market crash and TARP program spending caused a spike that has yet to end today.
  • But we all wonder if something is different is happening now.  America’s annual budget deficit is over 10% of GDP, and will be well over a trillion dollars per year for a decade or more if the President’s budget is approved.  Somehow we have gone from a structural deficit of 2-3% of GDP (the ‘normal’ range since the end of WWII) to levels more expected of a banana republic than the world’s most important industrial state.  And recent estimates by CBO and OMB suggest it may get even worse (from 3/15/10)

Our intuition that something is different this time is right.  Spending under the new President is rising at an unprecedented rate – and is moving from a historical average of around 20%of GDP to well north of 25% of GDP (and it is being structured as a permanent, not temporary, increase).  Despite planned tax increases of $3-trillion, the budget deficit in 2010 will likely reach $1.5 trillion, and after a brief easing will again begin to increase every year for the foreseeable future if and when ObamaCare passes in 2014.

Deficits Escalate Indefinitely

As a result of the President’s spending plans, CBO expects debt service (interest) alone to total over $800-billion per year by the end of the decade.  That’s an additional $74,000 in federal debt per household.  That’s over 20% of the expected budget.  It’s more than ‘overseas contingency operations’, more than Medicare, more than Social Security.  And that’s assuming no major increase in interest rates arrives  to spoil the party.

Can We Fund This Much Debt?

Not for long.

We’re already funding ½ of it with a printing press, and our lenders are beginning to balk at funding the rest.  And Moody’s fired another warning shot today, stating that the United States and UK are on a path to losing their AAA rating soon.  And every percentage point increase in interest rates over the next decade will increase annual debt service by almost $200-billion.  So a five year spike in rates of only 2% would  bump interest costs by another $2-trillion.  Could rates go from the modeled 6% range to 8% or more for a few years – like they were in the 70’s and 80’s?  Of course they could – and likely will if we keep running up the tab.  Indeed, it could get a lot worse.  At some point, inflation becomes inevitable and rate increases must follow.

Is That All?

No.  We actually have a lot more national and household debt and debt service than what the CBO shows in its limited accounting of the annual federal budget.  And our federal debt service capacity is shrinking because our tax system gets almost all of its revenues from people at the top of the income range – and their incomes (and resulting tax payments) are evaporating in the face of a crushing economy and punitive taxes.

So we are going to experience getting sandwiched between growing, debt-driven spending and the demise our major sources of funding.  So who is going to pay?

But we’ll get to all of that soon enough.

Reference articles:

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2 Responses to “ Are We Broke? Part I of Series ”

  1. momof3 on March 16, 2010 at 11:42 am

    Keep it up John. We need your analysis!

  2. Bill Reeves on March 18, 2010 at 2:30 pm

    Yes we are. And our kids are going to hate us sooooo much.

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