U.S. Debt - Down The Ponzi Scheme Rabbit Hole?

by: The Motley Monetarist

The Red Queen in Alice in Wonderland has poor Alice running in place very fast. Alice, perplexed, asks the Queen, "well in our country, you'd generally get to somewhere else - if you run very fast for a very long time as we've been doing." To which the Red Queen rejoinders, huffily, in a fit of logical but not misplaced absurdity, "a slow sort of country! Now here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!"

Similar reflections could be made about the recent debt ceiling limit controversy. Evoking the 14th Amendment, Senate Democrats are urging president Obama to raise the debt ceiling unilaterally. On the other hand, Republicans are resisting this effort.

Article 1, Section 8, clause 1 of the Constitution places the taxing and spending authority of the U.S. Government in the Congress. The question is, when does servicing of old debt become new spending, or when is it just past spending. If the latter, the President would have the authority to raise the debt ceiling, executing the past spending decisions of the Congress. If the former, presumably, the question of raising the debt ceiling to service past debt would have to be resubmitted to Congress.

The following graph, the data taken directly from the website of the White house, shows the net interest payment annually as a percentage of deficits each year, since 1962. The surplus is calculated in constant 2005 dollars as is net interest. Towards the end of the graph, we are representing White House estimates of net interest in the year 2017.

Click to enlarge

Source: whitehouse.gov/omb

It is clear, that based on the estimates of the OMB, net interest is anticipated to take over the deficit. The deficit of the U.S. government dipped to 10% of GDP, according to the OMB in 2009, at the height of the crisis. 2017 estimates have this percentage climbing back to the levels of 2008, the last Bush year.

However one wants to play the blame game regarding the relative responsibilities of President Obama versus Mr. Bush in this regard, one thing is clear - servicing of past debt is fast reaching Ponzi scheme levels as the ratio of net interest to the deficit attains 100% and beyond. It should be noted that the net interest to surplus variable reaches -10 towards the last year of the first Clinton mandate for a good reason - while the U.S. government deficit was climbing back to surplus, debt servicing remained the same.

Of course, it might be argued that from the graph that the net interest to deficit ratio had already attained stratospherically low levels historically - under Nixon and Reagan. To put this in perspective, however, look at the following graph of the 5-year annual interest rate for those very same years.


The high levels of net servicing of the debt under Nixon and Reagan can be attributed to record interest rates for those years. It is especially telling that net servicing of the debt might reach Nixon and Reagan levels even with interest rates that are close to reaching Japanese liquidity trap levels, leaving the Federal Reserve with few accommodating options to counteract swollen interest payments on past debt. The discrepancy is caused by the high degree of past debt overhang, likely to continue into the future.

A recent study released by the Congressional Research Service is relatively sanguine about whether the current level of the debt is unsustainable. While the author discusses the consequences of a credit downgrade, he doesn't discuss the lethal combination, as shown in the graphs above, of low interest rates and a net interest to deficit ratio reaching historical proportions. This combination is unprecedented in U.S. history (or at least in recent years).

In addition one of the key assumptions of the author is that government spending follows the golden rule. That, amongst other things, the government should borrow to invest and not finance current spending. This rule is not always obeyed. As of 2012, the percentage of total government outlays devoted to physical capital, research and development amounted to a paltry 15.6%, little changed from the mean of 15.5% between 1989-2012.

As the great eighteenth century philosopher and economist, David Hume commented, in his article On Public Credit, in a highly evocative way,

Public stocks, being a kind of paper credit, have all the disadvantages attending that species of money..they render all provisions and labor dearer than they otherwise would be, the taxes which are levied to pay the interests of these debts are apt either to heighten the price of labor, or be an oppression on the poorer sort, and as foreigners possess a great share of our national funds, they render the public, in a manner, tributary to them.

It's as if Mr. Hume had a crystal ball looking ahead three hundred years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.