America's Economic Realities

[Tom Joad]

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Mountains of Debt: America's Economic Realities
by Charles Wheelan, Ph.D.

Posted on Tuesday, June 23, 2009, 12:00AM

Ben Franklin supposedly said that it's better to skip supper and go to bed hungry than it is to wake up in debt. Ben would be quite disappointed in us. We Americans didn't skip dinner; instead, we opted over the past decade to gorge at the buffet and then charge it.

We woke up as the world's largest debtor -- so deeply in debt that our global creditors are getting nervous, and rightfully so.

Here are some economic realities associated with our deepening fiscal hole.

It's bad. As in, $11 trillion bad. That number alone doesn't mean much, at least without context. So here is some context. First, that's roughly $40,000 for every man, woman, and child in the country. Second, our debt is projected to grow to roughly 100 percent of GDP by 2010, meaning that, if we were to devote everything we produce as a nation to paying down debt, it would take us an entire year to pay off what we owe.

Eating Up the Global Capital Pool

Other countries have become more indebted as a percentage of GDP, but they were small countries, so they sucked up less of the global capital pool. There is only so much money in the world, and we have borrowed a shocking proportion of it. The only other time the U.S. has been so indebted was at the end of World War II.

Big debt means big interest payments. The Chinese haven't loaned us a trillion dollars because we're good-looking; they've loaned us a trillion dollars because we pay for the privilege of using that capital. Interest payments now make up more than 8 percent of the federal budget -- meaning that nearly one of every 10 of your tax dollars gets you absolutely nothing in return. No schools, no bridges, no domestic wiretaps. That's just the cost of servicing the debt we've run up.

And we've done nothing terribly productive with all that borrowed money. Debt, after all, is not inherently bad. If you borrow $100,000 to go to medical school, then you've probably done a very smart thing. When you graduate, your earning potential will be higher, enabling you to live better even after you pay off the loans (with interest). In this case, you used borrowed money to invest in something that made you more productive.

Now suppose that you borrowed $100,000 to sustain a lifestyle that you could not otherwise afford: to pay the rent, to buy nice clothes, and to make the payments on your luxury car. When that bill comes due (with interest), you're no more productive than you were when you started borrowing. You borrowed used money for consumption, not investment.

Unfortunately, America's borrowing resembles the latter more than the former. We haven't upgraded our transportation infrastructure or made major investments in alternative energy or financed education for those who could not otherwise afford it.

Stop the Bickering

We need to stop bickering about who got us here. Was it the Bush tax cuts (yes) or the Obama stimulus (yes) or profligate Congressional spending (yes) or voters who continually reward pork more than parsimony (yes)? But analyzing just overcomplicates things. We are deeply in debt because we have routinely spent more than we collect in taxes. That's just a mathematical reality that has become needlessly confounded with politics.

If you're a small government conservative, that's great. But let's say enough of the tax cuts without corresponding spending cuts. Those aren't tax cuts; they are tax postponements. You've just left the bill for future taxpayers, with interest.

And if you believe that government can and should build a stronger America, terrific. I'm sympathetic: I like early childhood education and the high-speed rail and Army sharpshooters who kill pirates. If you want those things, then pay for them.

Big government or small government, the revenues need to equal the expenditures. It really is that simple.

When the Big Bills Come Due

The big bills haven't even come due yet. If the U.S. were a family, we'd be crouched over the kitchen table trying to figure out how to pay the Amex and Visa bills -- and the gigantic Mastercard bill would still be in the mail.

The big bill still in the mail for the United States is for our entitlement programs -- primarily Social Security and Medicare. We've made huge commitments to these programs that are not adequately funded. That Social Security check you're counting on when you turn 65 doesn't show up in the debt figures, but it's still money that we will owe. Lots and lots of money.

And the Chinese are worried U.S. debt, as they should be. All debtors have creditors; ours are all over the world. The biggest one is the Chinese government, which has been buying up U.S. Treasury bonds with all the vigor and foresight of a 1990s Las Vegas real estate developer.

If we don't honor our bonds, China doesn't get to repossess the White House or the national parks; they don't get to carve their own leaders on Mt. Rushmore. Treasury debt is secured by the "full faith and credit of the U.S. government" -- which won't command much at auction, if it comes to a foreclosure type situation.

Chinese officials aren't worried about bankruptcy because the U.S. has an easier and more insidious option -- we can print our way out of the problem. Our debt is denominated in dollars, and the U.S. government has the authority to print those dollars. We could take a page from the Zimbabwe policy manual and just print money to pay our bills -- thereby debasing the currency, creating inflation, and devaluing the real value of what we owe.

Is that a sensible solution? No, as it imposes the costs of inflation on all of us. I don't know anyone eager to revisit the 1970s (in terms of economic performance or fashion).

Is it a possibility? You bet. In fact, I'm surprised that long-term interest rates haven't climbed more than they have. (When long-term lenders fear inflation, they demand higher interest rates to protect against that contingency.)

The solution to all this is straightforward: Spend less than we take in, and use the surplus to pay down debt. At the risk of lapsing into economics jargon, yes, this is going to suck. Think about it: Americans don't like their current tax bills -- which aren't even high enough to pay for our current spending, let alone the bills we've run up from the past. In the future, we will have to pay more and get less.

But we've done it before. We paid off the debt accumulated during World War II. In fact, the ensuing decades saw some of the most impressive gains in wealth and productivity in American history. But it will require a radical change from what we're doing now.

An economic recovery will help. But we can't pretend that will be enough. We need to raise taxes, cut spending, and/or reform our entitlement programs. Probably all three, and in a serious way.

Will that dampen economic growth in the short run? Yes. Will it jeopardize important social programs? Yes. Will it compromise our ability to make important public investments? Yes. Does it limit what we can spend on healthcare reform? Yes.

But as Ben Franklin would have pointed out, we should have thought about that before ordering room service and then charging it to a credit card.

[Francois Cellier]

Originally Posted by Tom Joad

But we've done it before. We paid off the debt accumulated during World War II. In fact, the ensuing decades saw some of the most impressive gains in wealth and productivity in American history. But it will require a radical change from what we're doing now.

The author forgets to mention one tiny detail.

How did the U.S. pay back its debt after WW-II? It was in fact surprisingly easy. The U.S. was the largest oil producer in the world. The energy economy had just started in time, partly driven by WW-II, and so, the U.S. could pay back their debt accumulated during the war by selling oil to the rest of the world.

Unfortunately, U.S. oil production peaked in 1970, and as of 1993, the U.S. became a net oil importer. Thus, the recipe of the past unfortunately won't help us this time around.

So, what will happen?

The U.S. debt must be serviced, and it will be. First, the U.S. will do what it always did: issue more government bonds, i.e., borrow new money to service the old debt. If there are no longer enough buyers for these new treasury bonds, the U.S. will have to raise the interest rate in order to find more buyers. If this doesn't work any longer, then the printing presses will have to be started to print the additional Dollar bills that are needed to service the old debt ... and this is the road to hyperinflation and ultimately collapse of the currency.

It has happened before, e.g. 1923/24 in Germany. It will happen again ... unfortunately this time around, it will happen "more close to home" for our American friends.

What is harder to predict is the effect of this happening on the world economy. As the U.S. Dollar is the defacto reserve currency of the entire world, a collapse of the U.S. Dollar will have ramifications all over the globe ... and unfortunately, this all comes at a time when oil is peaking world-wide, leading to more strains on the economy due to the increasing cost of paying for the energy that our economies need to stay afloat.

[Yorkist]

Forget about oil. The US economy cannot be rebuilt on oil. Sustainable recovery demands sustainable resources.

[Antiphon]

in the short term, it's not likely to be re-built without it.

[Francois Cellier]

Originally Posted by Antiphon

in the short term, it's not likely to be re-built without it.

In the short term, it's not likely to be re-built.

[potter]

Gosh..I guess it's time for Americans to get off their collective fat asses and start leading the way in renewable energy technology developement...just like Omaba suggested and is trying to do despite the party of "NO"....

[Yorkist]

Right on.

[Justin]

And yet, the brilliant economists (who also thought we'd see a soft-landing in the housing markets) think the key to US recovery is for consumers to start buying again.

Its a joke.

The US needs to save to produce and export, not borrow to consume and import. A healthy US economy isn't going to be accomplished by reinflating our most recent bubble, as the Fed-led Obama and Bush Administrations seem to want. The answer is to take our medicine, no matter how bad it tastes: let the economic correction do its job and fix the imbalances in the economy, and do our best with what results.

This isn't going to happen, unfortunately...as Obama's economic policy has shown. He's determined to keep borrowing without working towards a balanced budget.

We're getting closer to the day that our creditors stop buying our treasury bonds. And I, personally, don't believe the Fed will stand for interest rates much higher than they are now. High interest rates put a crimp on borrowing and spending, which will halt what they believe is the solution to the economic troubles: consumer spending.

We are headed for very high, or even hyper, inflation. The collapse of the dollar and the US economy. If it gets as bad as it could potentially be...then we could even be facing a breakup of the US. It didn't have to be this bad. The recession is the medicine for an unhealthy economy. Our leaders just won't let us take it.

[Tom Joad]

Originally Posted by Justin

We are headed for very high, or even hyper, inflation. The collapse of the dollar and the US economy. If it gets as bad as it could potentially be...then we could even be facing a breakup of the US.

[Justin]

Gig'em.