on 29-Nov-2015 (Sun)

However, with the exception of a brief period during and immediately after World War II, debt levels have never been as high as they are now.

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Currently, the national debt held by the public is about $13 trillion, which is around 74 percent of the country’s economy, as measured by Gross Domestic Product (GDP). The gross debt, which includes money owed to other parts of the federal government, is about $18 trillion, or roughly 102 percent of GDP.

For example, if we start now, we would need spending cuts and/or tax increases equaling 2.6 percent of the economy to bring the debt gradually down to historical levels in the next 25 years. Waiting 5 years, however, would require adjustments of 3.2 percent of GDP and waiting 10 years would require 4.2 percent. Waiting has real costs.

In 2015, the U.S. will spend $218 billion, or 6 percent of the federal budget, paying for interest on the debt.

The U.S. had budget surpluses from 1997-2000

The latest estimate of Laurence J. Kotlikoff (2011) puts the gap’s present value at the bone-crushing level of $211 trillion. A more modest estimate from Jagadeesh Gokhale and Kent A. Smetters (2006, 203) estimates the gap as of 2010 at $79.4 trillion. The Congressional Budget Office’s (CBO’s) most recent long- term outlook (2011, 80) has federal expenditures in its Alternative Fiscal Scenario—not counting interest on the accumulating national debt—rising by 2085 to nearly 35 percent of GDP whereas revenues will still be below 20 percent of GDP, a shortfall of almost 15 percent. Marc Joffe (2011), a former employee of Moody’s Analytics, projects that by 2040 the national debt will have already reached more than 180 percent of GDP and that interest alone will swallow nearly 40 percent of federal revenue.

The first, between Treasury debt and unfunded liabilities, is provided by the trust funds of Social Security, Medicare, and other, smaller federal insurance programs. These permit the illusion that the shaky fiscal status of social insurance has no direct effect on the government’s formal debt. But according to the latest intermediate projections of the Trustees, the Hospital Insurance (HI-Medicare Part A) trust fund will be out of money in 2024, and the Social Security (OASDI) trust funds will run out in 2036. The pessimistic projections have Hospital Insurance empty by 2017 and Social Security by 2030. 2

henever the trust funds are exhausted, payroll taxes will be insufficient and general revenues will have to finance these programs. Although other parts of Medicare and all of Medicaid already dip into general revenues, when HI and OASDI need to do so, the first firewall will vanish.

If investors react by requiring a risk premium on Treasury securities, the cost of rolling over the national debt will immediately rise.

As of September 2011, 15 percent of the Treasuries held by the general public

ncluding the Fed), or nearly $1.5 trillion, were Treasury bills, which mature in less than one year (Bureau of the Public Debt 2011).

The second financial firewall is between U.S. currency and government debt. The Federal Reserve could unleash the Zimbabwe option. My expectation is that, faced with the alternatives of seeing both the dollar and the debt become nearly worthless or defaulting on the debt while saving the dollar, the U.S. government will choose the latter.

Russia in 1998 is just one recent example of a government choosing partial debt repudiation over a collapse of its fiat currency (Chiodo and Owyang 2002).

the United Kingdom was able to successfully manage and reduce a World War II-government debt that had climbed all the way to 250 percent of GDP.

a more meaningful indicator is interest on government debt as percent of total revenue.

Doug Elmendorf (2009, slide 11), director of the CBO, provides some sobering calculations. The report’s Alternative Fiscal Scenario estimated that if federal revenues remained in the neighborhood of 20 percent of GDP for the next 75 years, while federal expenditures net of interest rose to 35 percent of GDP (roughly similar to the 2011 CBO estimate), adding interest payments from the accumulating national debt would drive total federal expenditures up to 75 percent of GDP by 2083, and that would entail interest amounting to a fantastic 40 percent of GDP. Obviously government finances will have reached an explosive tipping point long before that level is ever reached.

Yet if one is concerned about the looming fiscal gap, then one needs to add not just the trust funds but the remainder of the fiscal shortfall, yielding as mentioned above a total variously estimated between $79 trillion and $211 trillion.

The Federal Reserve, which is anomalously considered part of the public in official reports, holds about $1.6 trillion in Treasury securities as of September 2011, or almost 17 percent of the publicly held debt (Financial Management Service 2011). That percentage is not much higher than it was before the enormous increase in the Fed’s balance sheet brought on by the recent financial crisis. It could grow substantially if the Fed monetizes more Treasury debt, unless the Fed sterilizes its purchases by selling off its nearly $1 trillion worth of mortgage-backed securities and assorted miscellaneous assets. But to the extent that the Fed is now paying interest on bank reserves (and at a rate that exceeds the return on short-term Treasuries), this portion partly represents indirect holdings of private commercial banks and other depositories.

About 45 percent of the publicly held U.S. Treasuries is owned abroad,

Most of the interest that the Fed earns on its securities is now simply rebated to the Treasury, which consequently would directly lose an insignificant annual flow of revenue from repudiation

A sudden and unanticipated repudiation of a private debt, so long as no one expects it to be repeated or extended to other debts in the future, has only a distribution effect: The debtor gains by the exact same amount that the creditor loses, with no net wealth effect.