US Lurching Towards 'Debt Explosion'

We Just Can't Afford It!

By Howard Gold | 7 July 2009

How bad is the nation’s fiscal crisis? Worse than you think. Two reports published last month underscore how grim the outlook is. A report by the liberal Brookings Institution’s respected economist William G. Gale, along with Alan J. Auerbach of UC Berkeley, describes the situation in nearly apocalyptic terms. "The fiscal-year 2009 budget is enormous; the ten-year projection is clearly unsustainable; and the long-term outlook is dire and increasingly urgent," the two economists write.

And the Congressional Budget Office, a nonpartisan watchdog, also sounds the alarm: "The federal budget is on an unsustainable path— meaning that federal debt will continue to grow much faster than the economy over the long run," its June report reads. "Large budget deficits would reduce national saving, leading to more borrowing from abroad*[!?!] and less domestic investment, which in turn would depress income growth in the United States," the report continues. "Over time, [it] would seriously harm the economy."

How much money are we talking about? This year, the US deficit may hit $1.7 trillion, 12% of gross domestic product, the highest percentage since World War II. And Gale and Auerbach project annual deficits averaging $1 trillion a year until 2019. The total estimated ten-year deficit: a whopping $10 trillion. Although the two economists expect a recovery and the end of some crisis-relief programs to cut the deficit to 4.8% of GDP by 2012, they expect that percentage to move up again to 6.4% of GDP.

In the very long run, Social Security and especially Medicare will consume more and more resources. The CBO projects Medicare and Medicaid will account for 80% of the growth in spending between now and 2035, while Social Security will represent the other 20%. Right now, however, the main culprit is the thoroughly reckless policies of the Bush Administration and the equally reckless plans President Obama is currently cooking up— and the Republican and Democratic Congresses that approved them, or soon will.

Remember, back in 2000, the CBO was projecting $5.6 trillion in surpluses over this decade. The dot.com bust, the recession, and September 11th put an end to that. But policy decisions made the real difference. David Leonhardt of the New York Times analyzed ten years of CBO reports and found that 37% of the swing from surplus to deficits can be explained by the recessions of 2001 and this one. Another 33% came from "new legislation signed by Mr. Bush."

That includes the Medicare Prescription Drug Benefit and No Child Left Behind. President Obama’s continuation of other Bush programs [[the very first President to cut taxes in a time of not merely one, but 2½ wars: normxxx]], like the lion’s share of the tax cuts, will account for another 20% of the change. (That includes our declining military presence in Iraq and stepped-up involvement in Afghanistan.) And only 10% is from new legislation proposed by the current president— the stimulus bill and his agenda for energy, health care, and education.

In fact, says Diane Lim Rogers, chief economist of The Concord Coalition, a nonpartisan group that supports responsible fiscal policy, "the number-one most expensive item in the Obama administration is the extension of the Bush tax cuts." The president made repeal of the tax on top earners a centerpiece of his campaign while repeatedly pledging not to raise taxes on the middle class. But rescinding the cuts for the top tax bracket will save us "only" $600 billion; $2 trillion worth of tax cuts continue for everybody else, and they will cause the most red ink of all, Rogers says.

It’s now clear that extraordinarily low interest rates, financial shenanigans on Wall Street, and most of all, the housing bubble created the 2003-2007 recovery [[such as it was: normxxx]]. With subpar employment and GDP growth, cuts in marginal tax rates clearly had little impact this time around— except to make the deficit balloon. Yet it would seem to be politically impossible and economically inadvisable to let those cuts expire for everyone by the end of 2010, when we might just be emerging from the recession and joblessness may still be high.

I do see signs, however, that the American people are coming to grips with reality. Some 52% now think the deficit is a serious problem; during the campaign only 2% thought it was our most important economic problem. That’s a step forward, but it’s not enough. Truth is, we simply can’t afford any new domestic programs until we figure out how to pay for the ones we’ve got.

That includes universal health care coverage, education spending, and cap and trade. Heck, we can’t afford the current Medicare, Medicaid, and Social Security plans. If we continue on this path, we’ll need to seriously consider means testing people to make sure only the needy get access to these benefits— we may need to ration medical care as well.

Someone may have to tell families that their 85-year-old father is not going to get extraordinary care unless they’re willing to pay for it themselves (or they have the insurance coverage to do it). Somebody may have to tell Social Security recipients that they can’t get [early] benefits until they’re, say, 65. And someone may have to tell the public that if they want government services, they’re going to have to pay higher taxes— or expect fewer benefits.

"Doing nothing is not an option," writes Rogers on her EconomistMom blog. "Legislation must ultimately be adopted that raises revenue or reduces spending or both". Newsweek columnist Robert J. Samuelson writes , "The system has promised more than it can realistically deliver. We are borrowing not to finance investment in the future but to pay for today's welfare— present consumption. … The sensible thing would be to decide which forms of public welfare are needed to protect the vulnerable and to begin paring others.

The American people have been living in a dream world. They have just begun to realize that they can’t have a 5,000-square-foot McMansion unless their reliable income and/or net worth are many times what it actually is— without credit! And, are they ready to accept that they’ll have to pay more to get their trash collected and their kids educated, too?

Until we all grow up and accept the fact that there are limits to everything— including satisfying our wants and desires— we can’t expect craven politicians to do anything different from what they’re doing now. If we don’t change and we don’t pressure our elected officials to do the same, we might as well start firing up the printing presses now, because we’re going to need a lot more dollars to fill the deepening hole. [[And, remember, it's the middle-class that gets wiped out in a hyper-inflation!: normxxx]]

*But our overseas lenders have long ago gotten wise to us!

US Lurching Towards 'Debt Explosion'; Long-Term Interest Rates On Course To Double

By Philip Aldrick, Banking Editor, Telegraph, UK | 6 July 2009

The US economy is lurching towards crisis with long-term interest rates on course to double, crippling the country’s ability to pay its debts and potentially plunging it into another recession, according to a study by the US’s own central bank. In a 2003 paper, Thomas Laubach, the US Federal Reserve’s senior economist, calculated the impact on long-term interest rates of rising fiscal deficits and soaring national debt. Applying his assumptions to the recent spike in the US fiscal deficit and national debt, he found that long-term interests rates will double from their current 3.5%.

The impact would be devastating— making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research, called a "debt explosion". Mr Laubach’s study has implications for the UK, too, as public debt is soaring here also. But, a US crisis would have implications for the rest of the world, in any case.

Using historical examples for his paper, "New Evidence on the Interest Rate Effects of Budget Deficits and Debt", Mr Laubach came to the conclusion that "a percentage point increase in the projected deficit-to-GDP ratio raises the 10-year bond rate expected to prevail five years into the future by 20 to 40 basis points, a typical estimate is about 25 basis points". The US deficit has blown out from 3% to 13.5% in the past year but long-term rates are largely unchanged. Assuming Mr Laubach’s "typical estimate", long-term rates have to climb 2.5 percentage points.

He added: "Similarly, a percentage point increase in the projected debt-to-GDP ratio raises future interest rates by about 4 to 5 basis points." Economists are predicting a wide range of ratios but Mr Congdon said it was "not unreasonable" to assume debt doubling to 140%. At that level, Mr Laubach’s calculations would see long-term rates rise by 3.5 percentage points.

The study is damning because Mr Laubach was the Fed’s economist at the time, going on to become its senior economist between 2005 and 2008, when he stepped down. As a result, the doubling in rates is the US central bank’s own prediction. Mr Congdon said the study illustrated the "horrifying" consequences for leading western economies of bailing out their banks and attempting to stimulate markets by cutting taxes and boosting public spending. He said the markets had failed to digest fully the scale of fiscal largesse and said "current gilt yields [public debt] are extraordinarily low given the size of deficits".

Should the cost of raising or refinancing public debt in the markets double, "the debt could just explode", he said, adding that it would come to a head in "five to 10 years". The only way out of this mess is to get back to basics, which we are, by force of economic necesity doing. However Fiscal Discipline will come only when our Politicians realize that our country will not survive without "Trust in God" and stop putting all your trust in Government or the "Arm of Flesh".