The Federal Deficit
Myths and Realities
October 19, 2012
The current budget deficits... 1.3
trillion in 2011, $1.1 trillion in 2012--and the size of the national debt,
currently running north of $16 trillion and exceeding our Gross Domestic Product
GDP) for the first time since 1947 (see the chart below)... are a huge
problem, aren't they?! Well, actually, no, maybe not. Here's why.
To say it succinctly, (1) The U. S. doesn't have to pay off its national debt... ever! and (2) given that its national debt doesn't ever have to be repaid, what becomes important isn't the size of the debt per se but the interest payments on it. And that's equal to the size of the debt multiplied by the average interest on the debt. Federal budget deficits are running at record highs, but because interest rates are running at record lows, the amounts by which these $1.3 trillion and $1.1 trillion deficits have increased the interest payments on the national debt hasn't been astronomical. I haven't been able to cut-and-paste a chart that shows this interest cost as a percentage of the government's income. but it's shown in a hyperlinked General Accounting Office chart. And it's that chart
that we need to be watching, not the deficit chart below. Permanent Link to How Big Is the Budget Hole?
The chart plots the U. S. national debt as a percentage of the U. S. Gross Domestic Product (the national annual total income) through 2009. Starting at about 120% of the country's GDP in 1947 ("World War II"), the national debt fell until about 1973. Then in 1980, it began a rapid rise (because of the Reagan tax cuts?) until President Clinton took office in 1992. During the Clinton administration, the national debt fell rapidly. It rose slightly during the George W. Bush administration, and then exploded during the Great Recession, reaching a little over 100% of the Gross Domestic Product by the end of October, 2012.
So where are we right now? Right now, the national debt has reached about 100% of GDP, four years earlier than the Congressional Budget Office predicted. Now look at the chart below.
This chart suggests to me that the huge budget deficits incurred first by the Bush administration* and then by the Obama administration were as much a matter of shortfalls in government revenues as they were increased safety net payments (unemployment compensation, Medicaid). The shortfalls in government revenue are said to be the result of recession-reduced government receipts combined with growing effects of the Bush tax cuts. If the economy continues to improve, (1) government revenues should increase and government safety net payments should decrease, resulting in declining federal deficits, leading to a sustainable level of federal deficits. I should thinkt, though that efforts should be made to lower the level of ratio of interest paid on the national debt versus GDP as soon as is feasible. As the above chart shows, this was done during the latter 90's, putting us in good financial shape for today's soaring deficits. Right now, we're approaching the upper end of the historical interest-cost range, having spent up the cost cushion that the later 90's budget surpluses afforded us. So is the current budget deficit a crisis situation? Assuming that going over the "fiscal cliff" (letting the Bush tax cuts expire) doesn't land us in another back-to-back recession, we should get back to sustainable deficit levels within the next year or two, combined with concurrent increases in GDP. And even if we hit another recession, perhaps the boost in government revenue that comes from letting the Bush tax cuts expire might mitigate the impact of such a financial dip on government deficits. But for whatever it's worth, it looks to me as though we're not in fiscal danger just yet.
Note that the time to reduce budget deficits and the interest cost of the national debt is during times of prosperity, and this is just what happened during the latter nineties when a budget surplus allowed interest costs to sharply decline. On the other hand, unlike private individuals, governments need to boost their expenditures during a recession to
* - The extraordinary budget deficits of the Great Recession began with the $770 billion TARP (Troubled Assets Relief Program) in the fall of 2008. This $¾ trillion loan to banks that were too big to fail, was, in my opinion, a courageous and indispensably necessary step by the Bush administration. By now, these loans have been almost entirely repaid, but the repayments have gone into general government revenues rather than into paying down the deficit. Consequently, at least $¾ trillion of the $5 trillion deficit that Representative Boehner has accused the incumbent President of incurring was already spent before President Obama took office. However, I believe that had John McCain been elected president, the Republicans would have been just as socially responsible and just as fiscally enlightened as the Democrats have been. They supported unemployment benefits and other emergency measures during the 1981-1982 recession that Ronald Reagan inherited from the Carter administration, and during the 2002-2003 recession that President inherited from the Clinton administration. But not only is it humane to provide unemployment benefits during recessions, it's also necessary to keep money circulating through the economy. If people don't have money to buy goods and services during a recession, the economy shrinks, deepening the recession. (Remember that the next time some politician accuses the current sitting president of reckless deficit spending during a slump.)
U.S. Deficits and the National Debt - Council on Foreign Relations
Government - Interest Expense on the Debt Outstanding
United States public debt - Wikipedia, the free encyclopedia
What the hyperlinked interest cost chart shows is that the interest cost, as a percentage of the government's income, peaked at 14.4% in 1947. Then it fell to about 7.2% until about 1978 (Jimmy Carter's presidency). Beginning in 1978, it returned to 14.4%, remaining there until 1995, when it hit a new peak of 15% during the Clinton administration (presumably because of the double-digit inflation rates of the early eighties, combined with the Reagan tax cuts). At that point, the Republicans and the Democrats realized that they had to do something to lower the costs of servicing the national debt. Starting in 1998, the interest cost fell sharply to its midpoint of 7.2% by 2003, rose a bit to 8% from 2006 to 2008. It fell precipitously to 5.8% in 2009, but then began rising steeply during the Great Recession. Right now, it's back in nosebleed territory at a new all-time high above 16%. [.
Why the U. S. and Other Nations Don't Ever Have to Repay Their National Debts
OK. Let's go back to the claim that the U. S. doesn't have to pay off its national debt... ever! Why not? How can you keep borrowing more and more money and never have to pay it off?
The best analogy here might be what you could do if you could borrow money on your credit card at 2% interest (which is somewhat more than the average interest rate that the government currently has to pay on its bonds). Let's suppose you had an annual income of $100,000 a year, and you decided to dedicate 10% of your annual income to making interest payments on your revolving credit card debt. Ten percent of your $100,000 annual income is $10,000 a year for interest. How big a loan could you afford if you were willing to spend $10,000 a year on interest payments at 2%? The answer is $500,000. Wow! That's a pretty big loan.
Next, let's suppose that between inflation and merit raises, your income can be expected to increase 6% a year (which is a little less than the average annual rate at which the government's income has risen). In that case, next year, your income will rise to $106,000. You can increase your interest payment by 6%, from $10,000 to $10,600 while keeping your interest expense at 10% of your income. ($10,600 is 10% of $106,000.) But now you can borrow more money. How much more money? Well, an additional $600 in interest payments will support an additional $30,000 in loan size at 2% interest. Let's see. You're paying $10,600 in interest but you're netting $19,400 ($30,000 - $10,600) from this strategy without having to make any interest payments. You're borrowing the money to pay your interest cost and you're making a tidy $19,400 profit on top of it. Double-wow!!
Of course, there's a day of reckoning for this Ponzi scheme. You're piling up more and more debt that will have to be paid off some day. That day will come after you die and your will is probated. At that time, your credit card debt will have to be paid off by your estate before any of your heirs can claim any of their inheritances. (Presumably, your estate will be large enough to handle this.)
The same kind of situation exists with respect to governments' debts (not only the U. S. government's debts but the national debts of all the other sovereign countries that are also running perpetually expanding deficits these days). There will be days (or more realistically, years) of reckoning but they may be a century or two or three in the future. When they arrive, governments will have to inflate their way out of their predicaments. In that case, the losers will be the holders of government debt rather than the taxpayers in those countries. Of course, to the extent that the holders of government debt are taxpayers in those countries... for example., through pension funds or bank investments... taxpayers will end up holding the shrinking bag.
Wait a minute! What about default? There's been a lot of talk about Greece defaulting on its debt. What about that?
And the answer is: that's because Greece no longer has its own currency. The Eurozone presents a curious situation. The Lesser Depression has caught Europe betwixt and between. If Europe's finances were knitted together the way those of the United States are, Greek bonds would be backed by the European Central Bank and there would have been no concern about Greece defaulting. And in fact, this is what Mario Draghi and the European Central Bank have been doing for Greece, Spain, and Ireland. When interest rates have started to rise, the European Central Bank has stepped in to backstop them. European leaders have seen the need to accelerate the fusion of Europe into a closer-knit European Union. [To me, this is reminiscent of states rights versus federal rights in the early days of the U. S. It's as though Alabama and Mississippi were experiencing rising interest rates on their state-issued bonds, and New York and Connecticut, considering the Alabamians and Mississipians to be easy-going and unproductive, didn't want their hard-earned tax dollars bailing out those lazy Southerners.]
All countries which have their own currencies can inflate their ways out of debt threats.
There's another possible angle to this. If a major nation defaults on its sovereign debt, that's going to send shivers up and down the spines of potential investors who are considering investing in other governments' bonds. If Germany doesn't back Greece and Spain, Germany's interest rates are going to rise, too. It's "all for one and one for all". So I see strong vested interests in making sure that nations don't default.
Is Obama responsible for a $5 trillion increase in the debt- - The
National debt passes $16
trillion: Should you worry? - CBS News
Issue brief: Debt and Deficit - CBS News
CBO's Outlook Drastically Understates Nation's Debt Path - Budget
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