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The Federal Debt Crisis: Its NOW not Ten Years from Now

January 10, 2012

Its 2012 and the US debt stands at greater than $15 trillion and increasing rapidly with no end in sight. In fact, in 2009 our debt was $12 trillion an ungodly amount to be sure, but still more than $3 trillion lower than today. Just ten years ago, our debt was about $6 trillion. Thirty years ago it stood at almost exactly $1 trillion. Do these numbers scare you? They should. But incredibly, most Americans seem to have already forgotten or simply want to be no longer reminded, after the political grandstanding and games which resulted in no deficit deal this fall (but simply a postponement of these massive US economic problems to the future).

We can perhaps thank Europe for taking America’s own intractable problems off the front page, but that doesn’t mean our problems have gone away. Even with the mandatory “cuts” in spending by most estimates, our debt will grow to $25 trillion or more by the end of the decade. So this hardly deals with the problem.

So why should you be concerned? At the moment, the US government, the dollar, and US treasuries are viewed as the “safe haven” in a world market where there is great financial turmoil, particularly in Europe. This is more than ironic in light of our many structural economic problems which are probably not going to go away for a number of years (e.g. a deflating of the housing/real estate asset bubble, huge amounts of consumer debt, massive unprecedented money printing to name just a few). I will have more on these “other” economic problems in later blogs. But when it comes to the US debt , unless we can immediately (or within a couple of years) get our deficits down to near balance with the budget then US debt will begin to be priced as a much riskier asset, meaning the Chinese and the rest of the world that hold our treasuries wont be willing to buy any new treasuries unless their yield or interest rate goes up substantially. Rising interest rates will only compound the debt/deficit problem since it will increase the deficit further. (Note: We currently pay about $200 billion and even the very optimistic administration budget has these payments going up to $500 billion by 2015 and almost $1 trillion by 2021. However, these numbers could explode if interest rates on new debt go up substantially which seems very likely.)

What should the government do?

First, it must focus on reducing the deficit substantially NOW not later. I realize for Neo-Keynesians and for most politicians this is anathema as it involves a lot of major budget cuts (and significant tax reform and some tax hikes as well). Neo-Keynesians argue that one should cut slowly now, with more dramatic cuts later this decade. Politicians for the most part like this too because it allows them to kick the can down the road. They don’t have to enact any program cuts or tax increases that many will not like TODAY. Instead, they can do this much later. But unfortunately the debt problem and the markets cannot wait that long and soon will lose faith that these future cuts or revenue enhancements will actually happen at all, since the government does not have the will to do them NOW.

Second, the discussion needs to focus on truly substantial cuts in the near term. That we have ended up with “mandatory” budget cuts of a bit more than $1 trillion in the next ten years in a period when the deficit will be at least $10 trillion is ludicrous. It’s a bit like rearranging the deck chairs on the Titanic. The market for US debt isn’t going to be any better with the future US debt totalling $24 trillion rather than $25 trillion. And the risks of default (or very high inflation) wont be any lower.

Third, the near term cuts must recognize that the budget baseline has to start by being brought back to reality. One initial suggestion during the early discussions on the budget was to bring back all programs to pre-“stimulus” levels in 2008 when federal government outlays were just shy of $3 trillion (or even better in FY 2007 when it stood at $2.7 trillion). Since then, we have had a massive buildup of spending as it jumped to $3.5 trillion in FY 2009, stayed flat in FY 2010 and then broke that all time record in FY 2011 (ending 9/30/2011) of $3.6 trillion.  (And of course along with these huge increases in spending and falling tax revenues due to the weaker economy, our deficits have swelled from $0.2 and $0.5 trillion in FY 2007 and FY 2008 to the unprecedented levels of $1.4 trillion in 2009 and $1.3 trillion in both 2010 and 2011.)

To be sure, none of this will be easy and won’t be politically popular. No one wants to pay more in taxes or have their favorite tax deduction eliminated and interest groups will fight hard to retain their piece of the federal budget. But, I believe it is the ONLY way forward. If not we will see a huge US economic meltdown, which hurts everyone.

More on the specifics of tax reform, new tax revenues and government spending cuts in future blogs.

But for now, what do you think?

9 Comments
  1. Jeff permalink

    Yikes!

  2. Yep. I’ve been saying for awhile that we need both large spending cuts AND significant tax increases to claw our way out of this hole (rather than keep digging). Unfortunately, no-one likes this stance: Republicans can’t countenance any tax increases whatsoever and Democrats think we need to keep spending our way out of this recession. And, so, the can keeps getting kicked down the road. In my view, if there’s one reason that America has lost its mojo over the past 50 years, it’s that we’ve lost our ability to make sacrifices and postpone today’s pleasure for tomorrow’s benefit.

  3. John Stowell permalink

    First, Bruce, I think it is very cool that you’ve become a blogger. And I look forward to a future substantive discussion over the merits of The Beatles vs. The Rolling Stones, As for this topic, I agree with Richard in terms of his analysis of Washington’s sorry state. The lack of leadership is stunning and sickening. I think we all hope the nonsense stops with the election but, really, recent history doesn’t back that optimism up. Washington will just be arming itself for the Election 2014 cycle. Meantime, the deficits pile up and our kids’ future gets dimmer.

  4. Dale E. Heydlauff permalink

    Thank you for your erudite and compelling message, Bruce. I couldn’t agree more with your analysis and recommended response. It will take true statesmen, to be sure, to make the difficult calls required to arrest the growth in the debt, and then reduce it. It is truly foolhardy to presume it can be accomplished solely with budget cuts from discretionary programs. Entitlement spending has to be part of the equation. Similarly, it is ludicrous to argue that spending cuts alone can accomplish what’s necessary. Tax/revenue increases are required, preferably coupled with genuine reform of the tax code. Until his withdrawal from the presidential race, Herman Cain’s 9-9-9 plan was strongly embraced by many Americans, largely due to its simplicity. Who doesn’t get frustrated producing an accurate tax return before April 15?

    I encourage your readers to read the interview with former Ohio Senator John Glenn that was in the Columbus Dispatch on Sunday, January 8. The Senator understands what it will take, and argued persuasively for bipartisan cooperation to achieve the goal of true debt reduction. A good start would be adoption of the Simpson-Bowles debt reduction plan.

  5. Bruce,
    Welcome to the world of blogging – it’s been three years for me now and lots of fun.
    You asked what I thought – I am not convinced by your analysis. I don’t think that reducing expenditure is going to do it – it appears to me that the cummulative defecit is now too big to simply repay, so the US can only grow and inflate its way out of it. This is pretty much what happened after WWII when the level of debt was at about the current level in relation to GDP. It is interesting to note that at least since 1900 there has never been a sustained drop in cummulative debt, but wide variation in debt vs. GDP. So this isn’t a new problem at all and it isn’t even the worst its been (but the second worst). The current picture actually isn’t that bad in terms of interest on the debt vs. GDP.
    High levels of debt have typically been associated with war, from the Revolutionary War, the Civil War, WWI, WWII, Cold War and most recently the War on Terror. Perhaps this is where the US needs to look in terms of better managing the economy. It’s not just about trimming military expenditure, but actually resisting the temptation to engage in war and then regearing the economy to do something entirely more useful.

    • David….Thanks for your welcome to blogging and your comments. You make some good points but I think you are missing some key points about what I was trying to communicate:

      (1) The current debt as a % of GDP is higher than any other period since WW2 and will within a year or two be higher than any time since 1900. While you can draw some analogy between Iraq/Afghanistan and WW II, I think it is only a very limited analogy. Our war expenditures during the war on terror pale in comparison as a share of GDP to those in WWII. In fact, as evidence, debt as a % of GDP almost solely due to the WWII effort rose from only about 35% of GDP in 1940 to over 100% in 1945. But then after the war the debt as a % of GDP declined steadily such that it was about 50% of GDP in 1960 and 37% by 1970.

      In contrast, our debt as a share of GDP grew steadily during the Bush years from 2000 (62%) to 2007 (69%) due in part to the war on terror, but also steady growth in US govt. spending in general. However, these values have exploded since 2008 (from 70% of GDP to 100% today) rising by a jaw dropping $5 trillion dollars in a little more than 3 years. This is NOT due to the war on terror but rather major increases in all government spending term stimulus spending turned out to be and will grow again next year even as war expenditures have been wound down and overall defense spending has barely grown. I am afraid this is a VERY NEW PROBLEM. There is no time that I could ever find since the end of WW2 period where debt to GDP EVER exceeded 70% for any sustained period. And what worries me most is that this % by ALL estimates (including the optimistic Administration estimates) is expected to continue to grow for many years. This is a ticking time bomb that could explode at any time when coupled with our policy of tripling the money supply in just the last 2.5 years. A very weak US dollar, high inflation potentially double digit, rapidly falling US stock and bond markets AND much higher unemployment are all very possible consequences.

      (2) You are absolutely right that we must watch our defense spending in the future (and not get involved in unnecessary wars). I couldnt agree more. However, this is only a small part of the problem that we face in the future. Our biggest problem is the expected exploding growth of entitlement programs such as Social Security and Medicare (as the baby boomers begin to retire) which we have done nothing about. Our next biggest problems is Non-Defense spending which has grown unabated for decades. Finally, we MUST reform taxes in a way that doesnt hamper growth, and in fact if we do it correctly we should increase economic growth AND tax revenues. More on this in a later blog.

      (3) Historically, the US has been able to grow itself out of debt problems (e.g. the 1980s being an example), but I am afraid our current period is quite different. (1) We are already at very high debt levels (2) US consumers are all tapped out and owe more money than in any time in history, thus not likely to be a big source of GDP growth and (3) productivity growth which is the key to high economic growth has slowed and shows no immediate signs of picking up. The high tech gains of the 1990s and early 2000s have largely played themselves out.

    • Bruce,
      Thanks for the reply. Now the post makes the necessary points. But don’t underestimate the real cost of the war on terror – it far exceeds the direct costs in Iraq and Afghanistan. Just look at the total security costs across the US today (and other countries).
      David

  6. David Hunter permalink

    Bruce — I like “The Braine Trust”–but “Blog-o-Braine” has a nice ring to it too…

    Isn’t the greater part of the problem in ballooning entitlement programs? I don’t think you can solve the problem without addressing the long term imbalance in entitlement spending.

  7. William Hildeson permalink

    If there’s anything the financial crisis has taught us, it’s that no one will do anything until it’s too late. The tea party won’t allow tax increases and the democrats and seniors are afraid of cuts to the main entilement program. I think we need kamikaze politicians who aren’t concerned about themselves (getting re-elected) but more concerned about the country. The system isn’t structured to support that ideology though. So it’ll break… just a question of when.

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