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

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?