How Things Could Get Really Bad
I have argued that the current recession, while bad, isn’t as bad as President Obama and others have claimed. I still think this is the case, but I would change my mind based on new evidence. However, I think the current situation could end up leading to a really bad situation.
As I’ve noted in my last post and in comments to other posts that currently the U.S. relies to a considerable extent on foreigners to buy U.S. government debt. Further, without these foreign buyers of U.S. government debt the U.S. would likely have to offer its debt at a higher interest rate.
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. [1]
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. Instead we get insulting commentary by economic-know-nothings like Matthew Yglesias who calls those who disagree with him insane. We even get the same thing from those who do know about economics such as Brad DeLong. Instead of explaining why these worries are not significant instead those of us who hold these views are called idiots, fools, and so forth.
Could things get much worse? Yes, President Obama could be wrong. And if he is wrong things wont get better for a very long time. It is a rather sizable gamble the President is taking with not even token measures to address the fiscal imbalances that are threatening to spin wildly out of control.
Photo by Flickr user MotherPie under Creative Commons license.
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[1] I don’t know of the current $10 trillion includes and of the TARP money.
In an interesting book called The World is Curved the author claims that if China decided to stop buying our securities the long term rate would rise by 2%. He came to that conclusion through an interview process with financial movers and shakers. Guaging estimate that is certainly beyond my capabilities, but I wonder if that sounds about right, and (quantitatively) what that might mean for reduced GDP expnsion.
The author also pointed out – and we all know this – that a trade war could be the catalyst for reduced debt purchases by China. Unfortunately, Obama and Congress couldn’t control themselves and inserted Buy American languge into the bill.
I guess they like to play with fire.
Two things, Steve. First, most of our public debt continues to be in American hands. The amount being purchased by the Chinese or Japanese has increased and, as you say, it’s considerable but we’re not dependent on it. IMO that’s a hysterical, xenophobic exaggeration. I’m not saying that you’re being hysterical or xenophobic, just that there’s plenty of hysteria and xenophobia out there and it’s blowing the real nature of things out of proportion.
Second, you’re forgetting that we don’t need to be faster than the lion. We just need to be faster than the other guy. It may well be true that American public debt won’t be as attractive an investment as it might be or as it once was. It just needs to be more attractive than other alternatives and that appears to be holding good for right now.
Drew: The “Buy America” provisions are likely stupid and counter-productive… but, in fairness, there is a legitimate concern about shipping “stimulus” overseas. This is not quite a “beggar-thy-neighbor” policy, but rather is an attempt (almost certainly misguided) to contain the possibility of international free-riding on American stimulus efforts.
Steve: I largely agree with your analysis, though on the specifics of Social Security, the imbalances are not as bad as you suggest. It all depends on what assumptions you use for economic growth. But, even in the worst case scenario, Social Security never runs a deficit of worse that 2% of GDP in any given year even out 75 years. In short, Social Security, by itself, won’t bankrupt the country. If the rest of the budget was in balance, even in the worst years, paying for the Social Security shortfall out through pure deficit spending would actually reduce our net debt burden over time due to normal economic growth. And what’s more, Social Security does deserve a little fairness in the sense that if we had “lockboxed” the payroll tax surpluses (as Gore proposed in 2000) instead of using them to fund tax cuts for the wealthy, our entire fiscal situation would be different total (and much healthier). Anyway, that is a long way of getting to my conclusion which is that Medicare is what will bankrupt us, not Social Security.
At December 2008 22% of our govt debt was held by the Chinese. That sounds like enough that they matter alot.
But I guess that’s a question rather than an assertion.
In Smick’s book he laid out a case for why the Chinese would not stop buying our securities. I just can’t definitively remember the rationale. But I think it was no more complex than that their cheap currency/export economic strategy was bound to continue generating savings, and where the hell else were they going to put it?
Of course, the book was written before recent events.
Bernard –
I understand. And it was probably mostly just PR to the unions. But the issue was real enough that the administration felt the need to stroke the Canadians.
I agree with you.
But, sadly I think we will have to endure this this. The Thirties proved that the government consuming a large amount of the GNP does not work.
If you think Voo-Doo economics was bad; just wait till you get a face full of this Doo-Doo economics.
Then there is little hope indeed. Obama and his supporters like the commenters you mention use the appeal to experts to cover their ideas. But Philip Tetlock has discovered that so-called experts are little better than random chance in their expertise. Sometimes being much worse due to being seduced by their own biases.
My own experience is that the louder an “expert” argues and the more he relies on his expertise rather than arguing facts, the more you need to discount their view.
His advice on non-experts testing their hunches is revealing of the chance of the screaming experts being right:
Drew, do you have a citation for that? Here’s my citation which shows that among foreign holders of U. S. government debt, the Chinese hold about 22%. That’s not the same as the total percent they hold of U. S. government debt. We have a little over $10 trillion of U. S. public debt. As I calculate it, the Chinese hold about 6.5%
If I were a chick I’d be asking you to marry me right now. Happy Friday.
OK, so it may be important to establish how much we owe certain debtors. And I keep waiting for the Chinese Communist and other countries to send me a bill.
The larger problem is that we have mortgaged our future, up to our armpits. If I were my son, who is 25, I would be fighting mad. Had a conversation with him recently, and he is. The debt: he has as a US citizen, will be his destiny and responsibility to reconcile.
What the US is doing now is what any irresponsible person usually does in this situation. Get another credit card, extend the line of credit on the ones you possess, and just keep keeping on.
My son is a liberal democrat, voted for Obama, and the rates on his credit cards are going up.
One good thing to note on the deficit front: The accounting rules for the US Gov’t are going to become a whole lot more transparent:
“For his first annual budget next week, President Obama has banned four accounting gimmicks that President George W. Bush used to make deficit projections look smaller. The price of more honest bookkeeping: A budget that is $2.7 trillion deeper in the red over the next decade than it would otherwise appear, according to administration officials.”
Before one can deal with a problem, one has to admit to a problem and the depth of it.
Eneils:
You do realize that about 85% of the U.S. public debt was run up during the Administrations of Ronald Reagan, George H.W. Bush, and George Bush?
Our national debt is, and this just a simple fact, a consequence of Republican policies.
Now, that said, the issue is not our absolutely level of debt which is actually not that high compared to many other industrialized nations, it is the way we ran it up (to pay for current consumption) and our structural deficit.
And that is nice to know.
But like I said, “We just keep keeping on.”
If you ever think that I am defending anyone for overspending, you are wrong.
These are all irresponsible politicians that have put us in this dilemma. Both parties have contributed to the problem.
But, I think, the irresponsibility of the past is is personified in Obama.
Now is the the time to stop, since it is at the forefront of public awareness.
But… huh? Obama personifies the flawed fiscal policies of Reagan, Bush, and Bush? I wish you’d been making that argument during the campaign. All I heard here then was that he was a mad socialist intent on reversing all of the policies of Reagan, Bush, and Bush by raising taxes on the wealthy. Now it turns out he’s really a Republican in disguise! Wow!
What a shocker. Seriously!
The larger problem is that
weRepublican anministrations have mortgaged our future, up to our armpits.Bernard, you do know that all spending bills originate in Congress, right? You cannot blame the executive branch for all the excesses of the past thirty years. And I figure Reagan and Bush 43 should get to claim whatever grace period from Carter and Clinton respectively that Obama will now claim from Bush 43. And before you claim Clinton gave us unprecedented growth, I’ll note that Bush 43 inherited a recession from Clinton and his magnificent record was predicated on a telecom bubble, a .com bubble, and his holiday from history that we are still paying for.
Dave,
Yes, much of the current debt is held by Americans, what about 70% or so? Anyhow in looking at this article in the National Journal indicates that foreigners are indeed important and probably going to moreso in the future in terms of buying U.S. government debt. In particular the comments by Burtless and Sawhill.
I’m not trying to promote xenophobia or hysteria. I actually think that having foreigner owning large amounts of U.S. debt has some good aspects to it. If nothing else it will help with trade and stability. However, these are facts and to ignore them for reasons of political correctness is foolishness.
My whole point here is that we have serious fiscal imbalances in the not too distant future that if not addressed soon and coupled with large deficit spending now could make things really unpleasant. Not that we need to be worried about the Yellow Menace or anything like that. Get our longer term fiscal house in order while we are dealing with the short term recession.
Bernard,
Now that’s funny. You have been claiming I’m overly optimistic. Yes, I agree Social Security is managable under your conditions. I don’t think those conditions will obtain–i.e. the scenario you describe is crazy optimistic. I hope we get there, but I’m very skeptical we will. As such taking action now, that we can undo later if things do turn out really good, seems prudent, no?
Even if the Chinese only hold 6.5% of our debt, that is still enough to matter. IIRC, that is about the same percentage of bad home loans out there now and look at the problems that is causing.
As Polonius told his son Laertes:
Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
Charles:
I am sorry that you have not been paying attention to American politics over the past 30 years. Yes, technically spending bills originate in the House. In practice, the President sends over a budget that is adopted 95-98% unchanged by the Congress.
Clinton inherited a weak economy from Bush Sr. and passed a weakening one on to Bush Jr. But by any metric you choose to use, the Clinton years featured more wealth creation than did the Reagan years, or either of the Bushes. You can credit whomever you want with that… but facts are facts.
Steve:
With all due respect… there is a difference between long-term and short-term predictions. You and are have been arguing about whether our current recession will be the most severe since the Great Depression (my argument) or not (yours). I don’t see why/how that should affect our assessments of the next 50-75 years, which is the timeframe for discussions about Social Security. If you assume that our economy will grow roughly 2/3 as fast per year over the next 30 years as it has over the past 30 years (a tremendously pessimistic assumptions — mind bogglingly pessimistic), you come up with my 2% of GDP deficit for Social Security. If you simply assume that our economy over the next 30 years will grow at the same rate as over the past 30, then Social Security roughly breaks even, though not in any specific year necessarily. Remember, the “intermediate” assumption of the Social Security Trustees is 1.7% annual economic growth… which is low by historical standards. If you assume 2% the problem largely goes away.
I would urge one and all to read, actually read, and not rely on Fox News or the GOP leadership, the reports of the Social Security Trustees.
I recognize that and I tried to go out of my way to avoid accusing you of it. However, I think that there’s no dearth of people who take the truth of foreign involvement in our public debt to promote hysteria and xenophobia. I share the view that you suggested: the Chinese holding 6.5% of our public debt does little harm and, considering how large a proportion of their aggregate national wealth that comprises, it might make them think twice about saber-rattling in our direction.
Dave –
You are absolutely correct. Its 22% of foreign holders. My bad. Maybe that is why Smick’s people don’t think China could move the rates that much.
Sill, I have this open question to the commentators, even if China holds only 6-ish percent, most commodity market prices move considerably at the margin of supply and demand. Could the Chinese harm us? Anyone have the relevant insight?
“Our national debt is, and this just a simple fact, a consequence of Republican policies.”
C’mon, Bernard, that is just pure partisan (and terrible, just terrible) analysis.
Republican policies??
Federal revenues in real dollars have followed an almost straight line increase through every administration from Johnson through Bush. Today, essentially at the conclusion of the Bush administration, they are actually above the 45 year trend line. Now look at the composition of the spending. From a dead zero start, Great Society programs – the cornerstone of the Democratic legislative record – now account for 40% of the entire Federal budget, and 9% of GDP. And they are accelerating.
Please tell me you were making a tongue in cheek joke.
Your assertion is laughable.
Bernard, your condescension and insolence is duly noted. With a tug of the forelock and a “by your leave,” considering just how much of what has transpired the last 30 years has been off budget, I think Congress does have more than the 2-5 percent role you allow for them. And even then, to imagine that Congressional interests, requests and lobbying don’t influence the remainder of the budget submitted by the President is to display the level of ignorance you so graciously attribute to me. Of ocurse, YMMV.
Drew:
Yes, in real dollars federal revenue has increase… because the economy has grown. But as a percentage of GDP, federal outlays are essentially unchanged since the mid-1950s and down from the late-1960s. The federal government has been spending roughly 20% of GDP for 50 years!
Our deficits are almost wholly a function of changes in tax policy and trends in economic growth. They are not a function of “runaway” spending.
I don’t blame anyone for running deficits in recessions because recessions depress tax revenues and kick in some (usually relatively minor) counter-cyclical spending (though not this time, lol). But running deficits in good times is wholly a function of irresponsible tax policies, and unfortunately irresponsible tax policy has been almost the exclusive province of Republicans of late.
Call it partisan if you want. As I say, facts are facts.
And Charles… I think you’re beyond reason. If there is a Republican president and Democratic congress, it is Congresses fault that we spend too much. If a Dem president and GOP Congress, then everything is the President’s fault. If Clinton was hollowing out our military, why didn’t the GOP Congress do anything about it? Because… the system is so big that only the executive branch has the capability to put together a budget, while Congress put together a wish-list of pork to add to it. That is the nature of the beast. The thing is… all the pork, taken together, is chump change. Congress really does only affect 2-5% of the budget, and I swear to you, you will not find a serious analyst on either side of the aisle who argues otherwise. We live in a presidential system, and the president’s budget is, de facto, the national budget.
There’s some truth there,(he is a mad socialist).
If you compare him to the way some Republicans have acted over the the last few years, you may be right.
To me, fighting over the problems, and trying to assign blame, which can be attributed to all politicians, is really not the answer.
Therefore, trying to assign relief to a politician who just wants to do more of the same, is at the very least, unrealistic.
This is not about a particular party, it is what about what is best for this country. What republicans and democrats have done in the past; and doing more of the same, just ain’t going to get us to where we need to be.
We don’t want political insanity on steriods.
If it was wrong for republicans, wrong for democrats, it was wrong in the past, wrong in the present, and will do us harm in the future.
Feeling that a few people, one party, one philosophy has got us to this point, is folly beyond folly. Hating one or two individuals, the opposition, to justify current standards, is just wrong.
Bernard,
Look at the last 64 years and tell me what you see in terms of national debt and deficits? The idea of not having deficits is the exception not the norm. So I still think, even in the long term you are being overly optimistic.
And yes I have read the Trustee reports and the picture for Social Security isn’t very good. It will add alot of debt to our national debt and will start doing so fairly soon. By itself it isn’t horrible, but we don’t have just Social Security to deal with, but also Medicare. Together they present a very, very serious problem. But maybe we can solve the Medicare problem completely and not have to deal with Social Security. Again I think that is wildly optmistic. And it doesn’t just depend on economic growth rates. For God’s sake not too long ago we had many on the Left wanting to increase the fiscal imbalance in Medicare by a rather large amount. And Obama wants to expand health care coverage without addressing why health care costs are rising so rapidly. Increasing coverage and access is a sure fire way to make health care costs go up even faster thus exacerbating the problem in Medicare.
I still think you are wildly optimistic.
Bernard, I concur that facts are facts, but you are selectively using some and discarding others, while attributing words to me that I never said so you can ridicule my intent. Nice trick, but it is just that, a trick. As I try to avoid partisan hackery, I don’t think I ever said “Republican good, Democrat bad,” although you rather explicitly said that above.
Anyway, you avoided most of my substantial points and reiterated your talking points, but only after labeling me insane, or at least beyond reason. Gee, I feel special now. Do you feel like Young Mr. Yglesias or Professor DeLong?
Charles: I must have missed your substantive points… what were they? All I saw was a vague reference to informal Congressional pressures… which I guess, do indeed exist. But there is no way to prove or disprove that. All we have is (a) the president’s budget as submitted, and (b) the final budget as enacted. And I will say again, there is very little difference in any given year between the two. Now, if you want to call into being invisible conspiracies that constrain the President, go ahead. As I say, I deal in facts not convenient conjecture. If, on the other hand, you were trying to make a point about “off budget” items then you need to revisit the process. “Off budget” items are usually supplemental/emergency measures that a President chooses, usually for political reasons, to keep out of the budget, not some sort of autonomous Congressionally mandated spending. And indeed, Obama has specifically sought to bring a lot of these back “on budget” showing that it was always in the President’s power to do so. See here.
Now Steve: Look, if you disagree with the assumptions of the Trustees, then say which. Do you think the economy will grow at a slower rate over the next 30 years (1.7% per year) or at about the same rate (2.0% per year). If the latter, there is no problem with Social Security, if the former then there is a problem the size I said before… unless you disagree with some other assumption of the Trustees. Yes, it is unlikely that the rest of the budget will be in balance, though in fairness, under Clinton we ran surpluses. But the crisis is not Social Security’s fault. It is the fault of reckless tax cutters like GWB and his fanboys on this and other boards.
About health care… indeed… it will be hard to solve and Obama’s promises may lock him into some very costly and silly initiatives. I will argue against them if it comes to that, as I argued against Bush’s prescription drug benefit, which was much more dangerous to our fiscal health than anything Obama has proposed yet. If possible, could you send me the links to your passionate attacks on Bush when that passed?
Nice try, Bernard, but the BEA NIPA Tables (1.1, 3.1-3.3) are calling bullshirt on you. Your “analysis” is superficial and faulty. One can only hope it is benign misinterpretation.
The entire post WW II revenue (taxing) statistic as a percentage of GDP is 17.9%. However, we have some hangover from the WW II effect, and we have recent increases, which pump the number up. The truth is, if we set the stage: from 1955 through 1965 we ran in the 16% – 17% range. Today we are just above 20%. (And the spending number isn’t 20% in 1955, BTW. In the decade 1955 – 1965 spending ran right at 17% of GDP, the proverbial balanced budget.) Said another way, from a baseline of the decade 1955-1965, in the last 48 years, since the Great Society implementation, as a percentage of the size of our economy, we are taxing 3.5/16.5, or 21% more. We have hardly starved government of revenue.
More germane to the argument – in 1965 we spent about 9% of GDP on defense. We now spend about 4%. We have rotated our expenditures, freeing up 5% of GDP from defense to “something else,” social spending of course. And, as I pointed out previously, from a standing start in 1965, we are spending today on Great Society programs 40% of the current budget, and about 9% of GDP. That’s a 14% of GDP change in composition of spending from 1965 to today. That’s 14% out of 20%; that’s absolutely huge. And it is accelerating.
We absolutely have a runaway social spending problem. And if we look at estimates for 2015, 2020, 2030 etc we see estimates that the freight train called the Great Society programs alone, will take us to spending of 15%-20% of GDP.
No runaway spending problem? You must be joking. I though you had better facility with numbers?!
Drew:
I will make a follow-up post on this issue on my own site so I can properly format the tables.
The short version is that yes, the percentage of the federal budget devoted to defense has declined and that devoted to social programs has increased dramatically. That said, the United States percentage of global military expenditures has also increased dramatically, and by any realistic measure our military dominance has never been greater… so we’re not starving the military either.
But no, spending has not run away and the overall level of federal government spending is roughly in line with what it has been for 50 years. You claimed that it was basically a continuous increase. It has not been. And as a percentage of GDP the federal budget is within a couple of points of where is has been since the mid-1950. It has not doubled. It has not even gone up by 50%. I think that the fact that the federal budget as a percentage of GDP has increased by about 15% (from 18% to 20%) since 1957 is hardly an indication of runaway spending, especially since most of that runup occurred in the 1960s.
I was not talking about the future. Indeed, I believe we facing a genuine crisis with entitlements going forward, about 95% of which is related to health care.
Drew:
Oh, actually, now that I reread you post I see what you are saying. Yes “social spending” has increased very significantly.
In the end, our disagreement may be on the more basic issue of whether there is a fundamental difference between social spending and defense spending. Ultimately, my view is that in a democracy, government spending will be divided up as the electorate prefers. My “concern” is not really with how it is split up, but rather with the risks associated with the government getting so big that its revenue extraction harms the economy. From my perspective, in terms of the domestic economy, I don’t see any reason to prefer defense spending to say health care or welfare or whatever. We can debate the merits of those issue individually, and on those issues we probably would agree more than you might suspect. But my point is that this is not an issue of “affordability.” Old fashioned welfare was a terrible devastating policy, but it was not unaffordable.
Social security is another example. I think it is a terrible system, but I don’t think even as structured it is unaffordable in the sense of causing a major drag on the economy.
–BF
Bernard –
First, I did not know you had your own site, and would be interested in knowing its address, so I can take a read.
But look, the issue is NOT whether social or defense spending is better. Defense spending is a neccessary evil. And a total dead weight loss. Who in their right mind would want to spend a nickel if not for the realities of the world??
The real issue is this. Defense spending is the only major government expenditure I know of that behaves just as we would hope: it scales, and becomes a smaller fraction of our resources (GDP) over time. 40% at WWII. Teens in the 60’s. High single digits in the 70’s and 80’s and low single digits now. Perfect. There are only so many oceans to defend. So many deserts to kill terrorists.
But what has happened is that we have created a social spending machine that has grown, and continues to grow without a throttle. And who is surprised? Politicians promise ever more goodies for votes.
Economies like the US are huge. Things move slowly. But over 45 years we have gradually morphed, allocating ever more resources from the military to social spending. And although TOTAL spending may have remained relatively constant wrt GDP, this is an illusion. With the rotation that has occurred, social spending is a freight train coming down the track at double digit growth rates………….and the crutch of letting defense spending scale down has only so much yet to go.
We have a runaway social spending problem of the first order.
Steve Verdon, less prone to hyperbole than I, calls it “fiscal imbalance.”
I call it an effing nightmare about to consume us. Oh, and to the original point, this ain’t no Republican policy. Its the logical conclusion to Democratic wet dreams.
Of course it is. After all, the GOP has controlled the White house 28 of the last 36 years. So naturally, everything the the Democrats fault.
Bernard,
I’m not disagreeing with the Trustees Report. Nice attempt to imply otherwise. I am disagreeing with your assumption of no deficits ever again in about 30 years.
Also, I think you are engaging in misdirection. My point wasn’t that Social Security is in actuarial imbalance therefore bad things. It is that Medicare and Social Security are in actuarial imbalance and that coupled with large deficits for the next 2 or more years could be problematic and we should take steps now to reduce that actuarial imbalance.
Regarding posts on Bush’s prescription drug program, we do have a search function on this site Bernard. And do you really think I supported that atrocity? Unfortunately I’ve let my site expire so posts prior to here at OTB are not to be found.
Steve:
Fair enough on prescription drug benefit. I did try to google your views on it, but didn’t find anything.
I agree that we have a crisis looming… but to solve it we need to understand what is causing it. And the problem is not causes by some undifferentiated “entitlements,” it is caused very specifically by runaway health care costs. All the other stuff has some pretty simple solutions actually.
–BF
“And the problem is not causes by some undifferentiated “entitlements,” it is caused very specifically by runaway health care costs. All the other stuff has some pretty simple solutions actually.”
Fascinating. I guess if your world view in that just increasing taxes makes solutions simple, then indeed, no spending problem is difficult.
Specific runaway health costs? This is like the golfer who says “I’d have shot 72 and won the tournament if I could putt; I three putted number 3, 6, 14 and 18……..or I’d have won. Laughable.