The National Debt Crisis: Don’t Panic! All is Well!

January 4, 2012 in Health Policy, Misc by RangelMD

This year the total debt owed by the US Federal government exceeded 100% of the US  gross domestic economic output in goods and services (GDP) for the first time since World War II. This means that if the US government totally shut down (no social security checks, no military spending, no lights on at the White House) and 100% of every single paycheck made by Americans over this next year – 15 TRILLION – went to pay off this debt (assuming that GDP remained stable), we STILL would not have paid off the entire debt since the government would need to spend several billion just to pay off the accruing interest.

It’s stunning to think about the national debt in these terms.  What’s even more stunning is how brazenly both parties, liberals, and conservatives are willing to risk long term economic security to feed their own ideological interests.  A case in point is the NYT’s Paul Krugman who dismisses any short or long term concerns about the US debt with a fanciful wave of his a priori wand. What is Dr. Krugman’s calming tonic in the face of a 15 Trillion dollar IOU? Basically, he implies that the debt doesn’t matter as long as you can raise taxes and interest rates remain low.

Deficit-worriers portray a future in which we’re impoverished by the need to pay back money we’ve been borrowing. They see America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments . .

First, families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.

So as long as we have rich Americans from which the US government can feed from then we will be OK. After all, the top 5% of income earners pay 60% of the US income tax even though their income is 35% of all personal income. For liberals, as long as we can raise taxes, we can continue deficit spending ad nauseum.  For conservatives, it’s even worse. The mantra appears to be deficit spending with low taxes now (trickle down) and to hell with the future.

Of course, Krugman is correct . . . .  about the present. The enormous US debt does not pose a serious short term threat to the stability of the US economy or economic recovery.  Given the sheer size of the US economy, there is no credible risk that the US government would default on it’s debt nor is there any reason to believe that the market for US Treasury bonds would dry up or become unstable. And interest rates are at an all time low, thanks mostly to the severity of the recent recession and the efforts of the Federal Reserve to stimulate the economy through borrowing and investment.

But, like the sky diver falling without a parachute, the danger for the US economy lies not in the present while tumbling through space but at some point in the future when the ground makes its presence known. It’s inevitable that the economy will pick up steam and with growth will come a rise in interest rates. Even small increases in rates can have a profound impact on the interest we pay on the debt.  Right now the interest payment on the national debt is about $242 billion a year.  Interest rate increases over the next decade have the capability of causing the interest on the national debt to exceed $1 TRILLION a year! Chew on this number for a while. This amount represents mandatory spending that does not go towards any social program, military asset, or regulatory agency. These billions pay investors in the US debt of which almost 50% are now foreigners (mostly the central banks of China, Japan, the United Kingdom and Brazil).

There is a very real possibility of a spiraling and out of control situation to develop as the interest on the national debt becomes bigger. Growing entitlement programs (Social Security, Medicare, Medicaid) combined with the increased interest payments could cause mandatory spending to exceed total government revenue. At this point the government’s ability to manage the debt would become even more difficult from a budgetary and political standpoint. The remaining choices, massive cuts in discretionary spending (including defense), massive cuts in entitlement benefits, and/or massive tax increases would become ever more drastic and unpopular.  Just like today there would be government gridlock, indecision, and political pettiness all resulting in  action that will be too little, too late. Meanwhile, the spiral continues, with increased budget deficits creating an ever larger national debt with increased interest payments

What happens then? The problem is that nobody really knows, not even Dr. Krugman. There is a great amount of debate among economists about how big the national debt burden could become and when the economy would become negatively affected. There is evidence that among industrialized countries, those with national debt below 60% of GDP had better annual economic growth (3-4%) than those with debts of 90% or more of GDP (1.6%). Though it’s unclear whether the larger debts were due to a slower economy and a decrease in tax revenues, the possibility remains for a negative impact on economic growth. Krugman further tries to differentiate debt held by households from the national debt.

This is the point almost nobody seems to get — an over-borrowed family owes money to someone else; U.S. debt is, to a large extent, money we owe to ourselves.

No it’s not.  As mentioned, almost 50% of our debt is held by foreign banks. And we can’t just stop paying interest on the debt because it’s “money that we owe ourselves.”  A US default on its debt or even a perceived inability of the US government to pay interest on the debt would result in volatility in the bond market causing falling bond prices and increased interest rates which would worsen the budget crunch as previously stated.  The US government is very much like a household that is very overextended on its credit. It’s like a family taking advantage of a credit card with no limit and ridiculously low interest rates.  A default would wreck the world wide economy and impair the government’s ability to borrow more money at low interest rates.

But lets assume that Krugman is correct and we can go on borrowing forever because it’s money that we owe ourselves that we don’t have to pay back. The problem with this “all is well” approach is it does not take into account the possibility of a “perfect storm” of different economic factors combining with our debt burden to result in economic catastrophe. Greece is a good example. They were forced by the Economic Union to adopt the Euro at inflated exchange rates for the old drachma that severely impaired their ability to borrow and service their national debt.  Though the US does not face the same type of monetary problems, the recent collapse of the sub-prime lending market is a good example of an entirely new economic variable that was unforeseen by almost every economist.  Hence, like earthquakes, economic disasters are very hard to predict but inevitable. The US national debt is like the proverbial sword of Damocles hanging over our heads. It has the potential to dramatically worsen and complicate what would normally be a survivable economic crisis.

Above all, however, Krugman and everybody else want job growth combined with economic growth. The problem is that the current massive amount of government spending is poorly designed to deliver this.   John Maynard Keynes famously called for the government to “prime the pump” with government spending for goods and services to stimulate the economy but the 2011 Federal budget included over $2 Trillion in mandatory spending and most of it was spent -quite literally – on people who are NOT WORKING. Social security for retirees and people with disabilities. Medicare for people older than the traditional retirement age of 65. Medicaid much of which is for children and those on disability. Unemployment benefits for . . . . people who are unemployed! And the recent bank bailouts designed to keep bank employees who already have jobs from becoming unemployed.  Even recent massive spending on two wars was primarily spent overseas during the occupations to employ Iraqis, Afghanis, and other foreigners. In theory and except for Federal employees, US government spending does not result in the creation of a single new American job.  It helps to maintain the status quo. No wonder the recovery has been jobless and sluggish.

During World War II the US government spent several hundred billion dollars to directly employ Americans to provide goods and services for the war effort. The economy responded with the biggest peacetime expansion in history. But today we have a multi-Trillion dollar economy and a few hundred billion dollars in domestic spending here and there is not going to cut it. What is needed is a multi-Trillion dollar domestic spending bill for the direct employment of Americans for nationwide infrastructure improvements. Unfortunately, we’ve already used up our political capital with year after year of massive deficit spending regardless of crisis. At least World War II had an end. By 1946 we no longer needed thousands of tanks, planes, and ships to fight the fascist threat and so spending decreased dramatically to prewar levels. This fiscal rationality no longer applies. For three decades, nearly every Federal budget has been followed by an even bigger budget. We no longer have either the political foresight or will to constrain spending so that we can reserve massive spending increases for times of true emergencies.  We have been spending our “rainy day money” on sunny days and now we have nothing left.

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