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U.S. in Worse Shape than Greece

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.

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About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research.

Comments

  1. Mr. Verdon, no doubt. Federal revenue has taken a hit due to the recession and the substandard recovery, which makes the ludicrous increases in spending the last three years (note, it started before Obama) even more irresponsible.

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  2. lunaticllama says:

    1.) The U.S. has monetary policy autonomy. Greece does not. That makes a huge difference in the structural limits to how the U.S. responds to monetary problems.

    2.) That Chinese rating agency official quote is pure nonsense. A cheaper dollar does not indicate default at all. It simply indicates lower demand for dollars. If you want to run U.S. monetary policy for the benefit of the Chinese and other countries, by all means, say so. But to quote a Chinese propaganda statement about how bad it is that the U.S. isn’t doing more to alleviate Chinese inflation created by Chinese manipulation of their currency is just pure nonsense argumentation.

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  3. john personna says:

    The only problem with Gross’ claim is the word-tense, “is” when he really means “might become.”

    If it “is” right now, we should expect US and Greek bonds to trade at similar rates. Instead, the US 10 year bond is at 3% (actually equal to the long term inflation rate), and the Greek 10 year bond is way out there at close to 17%. Big difference.

    Now the interesting thing to me is how often this moment is either treated with hindsight (as if we are still in a 2008 stimulus binge) or with a projection out to 2030, assuming inaction.

    Wouldn’t it be better to grasp June 2011 a little more firmly?

    FWIW, that pinko Robert Reich has an interesting roundup of Democratic mood:

    … I made the rounds of Washington Democrats, repeatedly asking why no bold jobs plan is emerging.

    Here’s a sample of their responses:

    “Dead in the water. We’ll be lucky if we get votes to raise the debt ceiling without major spending cuts this year and next.”

    “Are you kidding? It’s all budget deficit, budget deficit, budget deficit. Nobody’s thinking about anything else.”

    “Republicans beat us up so bad over the first stimulus there’s no way we’re gonna try for a second.”

    “We got them [Republicans] cornered on Medicare. Now they want to change the subject to jobs. Forget it.”

    “No need. We’ll see job growth in the second half of the year.”

    “The President doesn’t want to put anything on the table he can’t get through Congress.”

    Not much engagement with June 2011 anywhere.

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  4. john personna says:

    Federal revenue has taken a hit due to the recession and the substandard recovery, which makes the ludicrous increases in spending the last three years (note, it started before Obama) even more irresponsible.

    Inaccurate. Spending as percentage of GDP, the only reasonable measure, peaked in 2009.

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  5. PD Shaw says:

    Now the interesting thing to me is how often this moment is either treated with hindsight (as if we are still in a 2008 stimulus binge) or with a projection out to 2030, assuming inaction.

    Wouldn’t it be better to grasp June 2011 a little more firmly?

    I think the problem is different. We know that interest rates are going to start rising at some point, though we don’t know when or what rate. Most, if not all, of the future projections I see assume continuing interest rates of near zero going out to term. That’s unrealistic, though I understand that picking rates might amount to a form of soothsaying.

    The country is mortgaged on variable rate notes and all signs point to the rates rising; it’s time to cut principle before that happens. If Congress could point out spending that would increase the income to pay down the notes, I would support it.

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  6. steve says:

    “Right now the national-debt-to-GDP ratio is approaching 100%”

    As I am sure you know, it is debt owed to the public which is most relevant. Also, we are talking about debt that goes out 50 years when we get to the $100 trillion claim. Not sure how relevant that really is other than for general discussion.

    Steve

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  7. john personna says:

    I think the problem is different. We know that interest rates are going to start rising at some point, though we don’t know when or what rate. Most, if not all, of the future projections I see assume continuing interest rates of near zero going out to term. That’s unrealistic, though I understand that picking rates might amount to a form of soothsaying.

    Total soothsaying, throwing the chicken bones.

    The country is mortgaged on variable rate notes and all signs point to the rates rising; it’s time to cut principle before that happens. If Congress could point out spending that would increase the income to pay down the notes, I would support it.

    Low interest rates have been supported on two fronts, US monetary policy played against a global savings glut.

    I would bet on somewhat higher rates (have done so by keeping funds in short term instruments), but I’m not sure the glut is really gone. It will probably serve as a force in the other direction.

    BTW, seen this? MR says Uh-oh

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  8. Inaccurate. Spending as percentage of GDP, the only reasonable measure, peaked in 2009.

    Nonsense. Just because it peaked in 2009 doesn’t mean it isn’t still out of whack. Spending as a percentage of GDP is still way above historical ratios since WWII.

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  9. john personna says:

    Charles, it’s a bad practice to reject facts, to call them “nonsense” when they are easily checked It is mentally corrosive.

    Actually you do something much weirder than that, don’t you? You say “nonsense” and then say “Just because it peaked in 2009 …”

    So it wasn’t nonsense after all?

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  10. john personna says:

    BTW Charles, look back up thread at that “roundup of Democratic mood”

    You are still arguing like it’s 2008, aren’t you?

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  11. OzarkHillbilly (used to be tom p) says:

    You know, I had a thing or 2 to say. Turns out, others already said that.

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  12. ponce says:

    To paraphrase Churchill:

    “U.S. bonds are the worst form of investment, except for all those other forms that have been tried from time to time.”

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  13. André Kenji says:

    The United States has nothing to do with Greece, a small and poor island in Europe mostly famous by being a fiscal raven for ships and for tourism. Besides that, Greece does not print dollars. I think that Argentina, Brazil and Mexico in the 80´s are a much better comparison. Obviously, no one is going to bail out the US.

    The most realistic scenario to me is the return of stagflation, or a similar scenario of Latin America in the 80´s, with periods of inflation alternating with periods of recession.

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  14. Rob in CT says:

    The debt load is getting scary, on that we agree. I’ve been worried about it since the Bush tax cuts were passed. Actually, I was concerned even during the 90s, because simply balancing the budget or running a tiny surplus isn’t sufficient during a huge economic boom. We should have saved more, I thought. Then the Bushies came in talking about refunding the surplus to the public by cutting taxes… ugh. Then the unfunded wars, medicare D, a financial panic, stimulus, extension of the tax cuts, *another war* (!)… so now it’s a lot worse.

    That said, pulling back on the reigns, hard, right now, is a bad idea. Yet because we failed, repeatedly, to cut spending during booms to save up for the busts, we’ve put ourselves in a really bad spot. And this time, it doesn’t look like the rest of the 1st world is going to fight a massively destructive war that leaves our economy basically untouched.

    I think we’ll muddle through with highish unemployment, anemic GDP growth, and the high debt load. The worry is what happens when the next recession hits. We won’t have really recovered from the big 2008-09 one and we’ll take another hit. Then what?

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  15. john personna says:

    I’m sure many here will view James K. Galbraith with suspicion. Sins of the father and all that, but he does a very thorough, if directed, history of US economic policy and growth.

    Why Not Keynes?

    The son is actually pretty “left” in our landscape as well. A good read just the same.

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  16. john personna says:

    Rob, Galbraith ties our feelings about debt back to early schools of economics, and I think makes a pretty good case that “good spending / bad spending” is anachronistic.

    Even if we put him at “half right” about that, at that level it serves as a caution for this semi-austerity that we all seem to be buying into.

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  17. john personna, ok, if it’s not nonsense then it is using statistics to deceive. Call it what you want, but if you are trying to imply that somehow spending is down in 2010 relative to historical numbers, well, that’s less than straightforward and honest and the most charitable thing I can say about it is that it is a cheap debating tactic. Generally, I use the word historical to mean more than just the previous year to take advantage of a relative decline based on two data points.

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  18. Andre Kenji says:

    Bruce Bartlett is right: the deficit is a problem because paying interest rates on debt is expensive and because the money that the government has to lend to pay the deficit is a drain in the economy.

    That´s why it´s a nonsense to say the Americans should worry about jobs instead of the deficit: there is a deep relationship between the two.

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  19. john personna says:

    Charles, I was careful to name a fact, strictly, without interpretation. I wrote:

    Inaccurate. Spending as percentage of GDP, the only reasonable measure, peaked in 2009.

    The correct answer, if you want to go from there is “yes, but …” To do anything else is to show an inability to reason.

    Now, more completely, did you read the “roundup of Democratic mood” that I directed you to?

    That captures why the 2009 peak is significant, and does point our current direction. We are in at least “semi” austerity.

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  20. john personna says:

    Andre, did you read the Galbraith piece?

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  21. Andre Kenji says:

    i´ve read, but I didn´t get the point here. It´s true that what most of the so called Keynesians preach has little to do with Keynes, but on the other hand *paying interest rates is expensive* and you can´t keep deficits of 10% of the GDP for long time. Besides that, money that´s used to buy Treasure Bonds is money that´s not used in the economy. That´s something that has to do with reality, not with Keynes or Ricardo.

    Soon or later the US will have to enact a tough austerity package(Maybe tougher than the one enacted by the British this year), with tax increases and spending cuts.

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  22. john personna says:

    Andre, I think the critical thing is the tension between spending and jobs, and the less-argument and more-emotion that cutting spending gets you both. (Galbraith relates this to early economics.)

    I’m not going to argue for big stimulus, because like most people here and in the country I have an aversion to it. Just the same, maybe the difference I have with the political right, is that I think that means I have to accept the downside.

    If we pull back on spending, even if we pull the tax-cut lever yet again, I don’t see a good economic argument that this provides stimulus of any kind.

    I see it as hunkering down and waiting for natural growth, even if that is 10 or 15 years from now.

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  23. john personna says:

    (If you think Republicans and Democrats are each half-right, that might put you in my territory.)

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  24. Andre Kenji says:

    The critical thing is the deficit. High deficits means higher interest rates and smaller growth. That means less jobs. Both things are highly dependent, not exclusive. I grew up in Brazil, I grew up listening about IMF and things alike as a child.

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  25. john personna says:

    Andre, why would you argue “high deficits means higher interest rates” when we don’t have high interest rates?

    We do see, as with Greece, that inability to pay leads to high interest rates.

    And it especially strange to invoke the IMF, whose advice is often austerity, and who is criticized for lower growth, on that basis.

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  26. André Kenji says:

    “Andre, why would you argue “high deficits means higher interest rates” when we don’t have high interest rates?”

    Because China, Japan and other countries were buying American Debt to keep their currency low, now it´s the Fed that´s printing money to buy the same debt(That usually means inflation in a low unemployment scenario). That´s why so many people pay attention to Bill Gross, that´s saying that he is not going to buy Treasury Bonds with the interest rates that you have now.

    When there is no China or Fed to buy American Debt then interest rates will increase.

    “And it especially strange to invoke the IMF, whose advice is often austerity, and who is criticized for lower growth, on that basis.”

    I did not invoke the IMF. What I pointed out is that I GREW in a country with high inflation and high debt. Most Americans don´t remember what is inflation. I do.

    Besides that, the IMF does not give advice. They lent money to countries, and then they impose conditions, including austerity, so they can have their money back. Simple as that. Creditors have great influence over monetary polices of highly indebted countries.

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  27. john personna says:

    Andre, you didn’t directly answer my question. You have low rates, and a separate reason for low rates, the Asian savings glut. As I said above:

    Low interest rates have been supported on two fronts, US monetary policy played against a global savings glut.

    I would bet on somewhat higher rates (have done so by keeping funds in short term instruments), but I’m not sure the glut is really gone. It will probably serve as a force in the other direction.

    An assurance from you that rates will rise … did you see where we talked about “soothsayers” and “throwing the chicken bones” above?

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