During the discussions surrounding TARP and the stimulus spending one of the potential problems I mentioned was how the bond market would react to the substantial increases in debt the U.S. was taking on. Now Pimco’s Bill Gross has stated that when you add on future liabilities from Medicare and Social Security to the existing debt of $14.3 trillion the U.S. is in worse shape than Greece.
Much of the public focus is on the nation’s public debt, which is $14.3 trillion. But that doesn’t include money guaranteed for Medicare, Medicaid and Social Security, which comes to close to $50 trillion, according to government figures.
The government also is on the hook for other debts such as the programs related to the bailout of the financial system following the crisis of 2008 and 2009, government figures show.
Taken together, Gross puts the total at “nearly $100 trillion,” that while perhaps a bit on the high side, places the country in a highly unenviable fiscal position that he said won’t find a solution overnight.
Previously I had written,
At the same time the current recession will likely result in a budget deficit of at least a trillion dollars this year and probably next. Further, we have TARP, the current stimulus plan and a $75 billion dollar proposal to help bailout homeowners sideways on their mortgages and talk of TARP 2.0. All of this could add close to $2.3 trillion dollars to the national debt. Adding on the deficits just due to reduced tax revenues and we are looking at $4.3 trillion dollars, at least. Currently the national debt is around $10 trillion. So in a few years we could be looking at a national debt of $14 trillion dollars.
In addition as I have mentioned several times Medicare and Social Security are in actuarial imbalance to the tune of at least $40 trillion dollars. Further, the problem with Social Security and Medicare are not that far off.
All of this combined could make foreign buyers of U.S. government debt very cautious of buying even more. The U.S. could have to offer such debt at a higher interest rate. The effects of this would be to reduce potential economic growth for the foreseeable future. The higher interest rates would likely mean less investment in productive private endeavors reducing growth. Further, since we’d have a harder time borrowing the government might resort to increasing taxes simply to pay for some of this spending. And to make matters worse even higher taxes might be needed to try and address the magnitude of the national debt. All of these things would mean slower growth.
The only hope is that Obama and his supporters are absolutely right. That the stimulus package will have a significant multiplier effect that will offset to a significant degree the increased debt the country is taking on. I, personally, am skeptical of this. For decades economists felt that Keynesian stimulus spending would either be too late or not produce the multiplier theory often predicted. But now all that no longer holds. They trot out new theoretical arguments, but in the end it is still a gamble with no measures to address the country’s precarious fiscal situation.
And we have this story from a few days ago about how the president of the Chinese rating agency Dagong Global Credit Rating Co. Ltd already considers the U.S. in default.
“In our opinion, the United States has already been defaulting” on its sovereign debt Guan argued that by allowing the dollar to weaken against other currencies, the U.S. had eroded the value of Treasury bonds held by foreign investors, including China. That loss of value, he said, put Washington in de facto default on its obligations.
Yeah, it is pretty dubious, but if they become less interested in buying U.S. bonds, that could be problematic. Still the article goes on,
All three of the major American rating agencies continue to give U.S. government debt their top rating. However, Fitch, Moody’s and Standard & Poor’s have all warned that rating would be downgraded if Congress fails to raise the debt ceiling by Aug. 2, the date when the Treasury Department says the government can no longer legally borrow money.
The Chinese government is the largest holder of Treasury securities in the world, but it has been shedding them lately over worries that the governments massive stimulus spending, financed by borrowing, will lower the value of its holdings by weakening the dollar – the scenario Guan said is already playing out. Chinas holdings of American sovereign debt have fallen from a peak of $1.175 trillion last October to $1.145 trillion as of March, and the government continues to sell.
Right now the national-debt-to-GDP ratio is approaching 100%. And we have to keep in mind that Bill Gross and the Chinese have their own agendas with regards to the issue of public debt. However back in late 2009 I pointed to an article by Rogoff and Rienhart on financial crises. One of their conclusions,
Needless to say, a near doubling of the U.S. national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates and a collapse in today’s bond-market bubble. The legacy of high government debt is yet another reason why the current crisis could mean stunted U.S. growth for at least five to seven more years.
We might be looking at a potential fiscal crisis. I sure hope not. Right now the U.S. has the best credit rating. We have a good credit history. So, that definitely helps, but the possibility of a fiscal crisis is something to keep in mind. And the implications are that we need to address the issue now and it can’t all be done on one side, that is both spending and revenue will have to be addressed.
Update: From the comments, frequent commenter steve, writes,
As I am sure you know, it is debt owed to the public which is most relevant.
I disagree with this. The research of Rogoff and Rienhart suggests that when a country experiences a financial crisis and the debt-to-GDP ratio goes over 90% (this is public debt) then economic growth will typically be reduced by 1% going forward. Given that decrease is going to be in effect for a number of years that raises the cost of the financial crisis by trillions of dollars and will make it harder to service our debt going forward.
It was also pointed out that to get to the big scary numbers you have to look 50 years or more years out. This is true, but the point is that the path is unsustainable. That is $50 trillion over an above what the economy is expected to earn during that time frame. It is like saying, “I’m 22, just got out of college and I’m not even going to be close to retiring for 40+ years, so why even worry about saving now, I’m just going to spend it all.” I think that would be considered a rather poor choice by most. At least start putting something into your 401k or whatever retirement vehicle you are using.
