U.S. Government Debt/Deficit: A Disaster in the Making?

For the U.S. government's fiscal year ending September 30, 2008 the total federal debt level reached $10 trillion. Michael Pakko, an economist with the Federal Reserve Bank of St. Louis, notes in a recent article that the rise in government spending and debt is a ticking time bomb. What contributes to the debt explosion is the rise in entitlement programs.

All told, the shortfall for government social insurance programs (Social Security, unfunded obligations of Medicare Part A & B and Medicare Part D-prescription drug coverage) comes to a present value of $40.9 trillion. This is the government’s official estimate—some private sector economists suggest that the total burden is even greater. Economist Lawrence Kotlikoff has recently estimated the total unfunded liabilities of current federal programs at $70 trillion.

Recent bailout actions are also contributing to the rise in obligations that will need to be repaid by U.S. taxpayers. Forecasts from the Government Accountability Office show the growth of the debt obligations if entitlement reforms are note undertaken. The below graph depicts the growth in expenses compared to total revenue as a percent of GDP out to 2080.

click to enlarge

And, the resulting growth in the government's debt:

click to enlarge

The ballooning deficits and debt levels are issues that will need to be addressed sooner versus later in order to ensure healthy economic growth in the long run. Michael Pakko concludes the following:

Current measures of the federal deficit and the national debt, as dismal as they might appear, fail to reflect full consequences of current-law fiscal policy. The unfunded future liabilities of government entitlement programs imply rising deficits and a ballooning public debt far larger than today’s shortfalls. And debates about the immediate economic impact of government deficits on private savings and interest rates, while of academic interest, fail to address the full importance of these long-run consequences. Fundamental reform of entitlement programs is critical for putting U.S. fiscal policy on a long-run sustainable path.

Take the Fed's Flash Poll:

• What would you do to trim the debt and deficit?

Source:

• Deficits, Debt and Looming Disaster: Reform of Entitlement Programs May Be the Only Hope, The Regional Economist, By: Michael Pakko, January 2009.

Comments

[Steven Hansen:]

David, the social security and medicare programs are still making a profit. at the worst postulated time, their revenue will cover 70% to 80% of the programs current entitlements.

this leads to very interesting issues:

1) the profits currently are used to pay about 40% of the debt. is the government willing to isolate this money and not commingle these this with the general fund?

2) this program is a ponzi scheme. we have known this for ages. would it not be easier to simply pass a law which says payments under this system cannot exceed revenue. then sometime between 2020 and 2040, the social security benefits would slowly be reduced. this is enough time for people to create income vehicles to accommodate this shortfall.

3) the politicians want to adjust the fund today to raid the coffers. I say do the opposite - force them to isolate the entitlements to stop the gaimes.

Jan 12 05:19 AM

[wpdragon:]

I'm 58 and have been contributing more than my fair share to this despicable scam for my entire working life, with the expectation that at some point my government would do the right thing and provide me with enough of MY FUNDS to survive financially at least at some subsistence level.

I didn't ask Reagan and the Republican party to start exponentially increasing deficit spending and setting off a 30 year drunken orgy of irresponsible pork barrell spending, idiotic war-making, and shipping millions of American jobs overseas under the lie known as "free trade". And yes the Democrats were complicit in this con job perpetrated on American workers.

Now our trade and budget deficits are through the roof and the guvmint evidently thinks I and millions of others who played along with their despicable lies are going to just quietly give up any hope of surviving on a semi reasonable "retirement" (yah, that's a laugh) like the docile sheep we have proven ourselves to be.

Maybe its time to take a serious look at the 2nd amendment if that's what they think.

Jan 12 10:27 AM

[Capitalist ...:]

Entitlements will be tempered by budgetary limitations. Once the US government's debt to ratio hits a critical mass. Foreign funding of our budget defecits will cease and entitlements will be hit hard.

It would be best to save for the inevitable rainy day.

Jan 12 10:45 AM

[robert.b.fe...:]

When LBJ opened the Social Security trust to the general fund in the name of the "The Great Society." the jig was up for social security as a viable entity. Medicare/medicaid was never a viable entity. We need to create semi private accounts much like government sponsered 401K plans with a third party administrator to ensure that the government keeps it's hands off for taxpayers 45 years and younger. For those of us over age 45 I sure hope you have taken steps to assure you have some retirement income. Uncle sugar may not be there for you.

Jan 12 11:40 AM

[A Hoodbhoy:]

In a few weeks we will all be "issued" a National Credit Card by our government with essentially no obligations to pay any of the funds back. The government will borrow the funds with an obligation to pay them back to the Chinese, Japanese, and the Arabs. However they will "loan" all of us those funds with no concrete plan to get the funds back from us.
Is the US Government Debt/Deficit a disaster in the making? From my perspective, there is no doubt that it is a major fiasco in the making.

Jan 12 12:59 PM

[henarl:]

There is no way that the US debt can ever be paid back with real honest dollars. It will either be paid back with Zimbabwe type dollars or it will be cancelled by default. Our government would prefer the former solution by inflation but, if not successful in that attempt, never doubt that they will resort to the latter. Fortunately, that final determination is probably several years away. Meanwhile the excessive government spending will continue thruout the empires final years.

Jan 12 01:32 PM

[sr9web:]

Another imbecile blaming Republicans...
Last time I checked, Tip O'Neil and the DEMOCRATS were in charge of Congress and the budget during the Reagan years...

On Jan 12 10:27 AM wpdragon wrote:

> I'm 58 and have been contributing more than my fair share to this
> despicable scam for my entire working life, with the expectation
> that at some point my government would do the right thing and provide
> me with enough of MY FUNDS to survive financially at least at some
> subsistence level.
>
> I didn't ask Reagan and the Republican party to start exponentially
> increasing deficit spending and setting off a 30 year drunken orgy
> of irresponsible pork barrell spending, idiotic war-making, and shipping
> millions of American jobs overseas under the lie known as "free trade".
> And yes the Democrats were complicit in this con job perpetrated
> on American workers.
>
> Now our trade and budget deficits are through the roof and the guvmint
> evidently thinks I and millions of others who played along with their
> despicable lies are going to just quietly give up any hope of surviving
> on a semi reasonable "retirement" (yah, that's a laugh) like the
> docile sheep we have proven ourselves to be.
>
> Maybe its time to take a serious look at the 2nd amendment if that's
> what they think.

Jan 12 10:40 PM

[derryl:]

I see that my comment got very long so I'll conclude at the outset that we should take a look at Warren Mosler's 'Soft Currency Economics' for some solutions to the escalating public and private debt that are the inevitable outcome of our fiat money system. Read Murray Rothbard if you think fiat money is the problem and gold is the answer, but even goldbugs should give Mosler an honest read to see that fiat money is not unvarnished evil. Mosler thoroughly understands fiat money and essentially describes the ways that the Fed and Treasury should monetize public debt to allow the economy to function without periodic money supply depressions.

The hand has written elsewhere that our economic model is broken because it cannot function without ever increasing credit that provides new money to earn as income or profit and payout old debt. This is consistent with Milton Friedman's conclusion that the Fed should be replaced with a laptop computer that inflates the money supply by 2% annually come hell or high water. In the 1920s and 30s CH Douglas promoted another version of this cure with his 'social credit' monetary system that featured injections of non-debt money as 'national dividends'.

The system IS broken. We are where fractional reserve fiat money invariably leads to, under our current understanding of money. In our system all money is issued as debt that must be repaid. The money is created when it is originally 'loaned' and it is destroyed when the principal is repaid. If all debt is repaid there will be no 'money' in the system.

Money makes our world go round. Unless we are willing to devolve to a primitive barter economy we need money that 'works'.

Fiat money is just numbers so it's not as if the same physical money gets reloaned, though the fractional reserve 'depository institution' banking system is designed to both create new deposits and recirculate people's deposited savings. This system can only function sustainably if there is no leakage of money that is held outside bank accounts, and it is not realistic to assume that this will be the case because in fact it does not work like this. A 'mark of the beast' closed-system global money system would solve this problem, but we don't want to go there.

The trouble with our system, which is used everywhere in the world today, is that there is no external source of non-debt money that can be left circulating in the economy when debts are being rapidly paid down. Rapid debt paydown is rapid circulating money supply contraction, as borrowers take money out of the economy to repay principal, which destroys that money. Only new loans can put that money back into the system.

Bank loan defaults help, because the person who defaults has already paid the loan money to someone else to buy a house or a vacation, and the person who 'earned' the money from the defaulting borrower does not have to pay the money back. This leaves 'owned' money in the system, but at the price of bankruptcies and destroyed creditworthiness.

After a long run of business cycles and bankruptcies like we are at now there is a lot of 'owned' money in the system, in addition to all the debt-money still circulating (which eventually has to be paid back and destroyed). One problem is that some people are really good at acquiring a lot of money. You acquire money by earning it then not spending it to consume the goods that were produced when you earned the money.

This wouldn't be such a problem if the money-owners were satisfied to deposit their money in banks to be re-lent to new borrowers at a bit of an interest spread. The borrowers would use the loans to finance consumption of goods that are already paid for and owned by the people and businesses that produced them and now offer them for sale. The interest spread would be Friedman's 'necessary inflation' that keeps the system funded with enough new money for everyone to keep paying their debts.

Douglas' insight was that companies must collect more money in the total prices of their output than the total amount of money they distribute as their costs of production. The difference is their profit, which is what motivates anyone to do business (or go to work) in the first place.

The total amount of money distributed in an economy as business's collective costs is the total amount of 'earned money' in the system. Inasmuch as governments fund their spending from taxes on earned income, government spending does not add new money to this system.

The people who earn the money do not have to pay it back like loans. This money is owned by those people. But the trouble is that the total amount of earned/owned money in the system is only equal to the total amount businesses spent as their costs. There is no additional owned money available for them to collect as profits. Collectively, the only way all businesses can make profit is if consumers borrow new money to purchase business's outputs at profitable prices.

Creative destruction is fine so long as only nonviable businesses are going broke. But in a money supply recession (or 'balance sheet' recession) a lot of good businesses get cash starved and go broke too. Good workers also get laid off and go broke through no real fault of their own. Douglas calls this loss of 'effective demand'. Wanting something is not 'effective' if you have no money to buy that thing.

This is not a business problem or a problem of economic supply and demand. The demand for these firms' products is still there, but nobody has money to buy their stuff. So everybody cuts production and lays off workers and we go to the deflationary spiral we're threatened with now.

This is a monetary problem that requires a monetary solution. Mosler, much like CH Douglas, advocates government creating and spending new money and monetizing public debt.

There is a moral arithmetic to private debt that does not apply to a money system (like the US dollar) as a whole (though in a global economy with national currencies like we have, national balance of trade debt is equivalent to private debt; some global cooperation like G20-G100 will be required to address this problem). It is immoral for a person to consume more than he earns, a kind of theft of other people's work. The total amount of the theft is the amount of that person's monetary 'debt'.

But after decades of fiat money creation half the population is in debt and any pinch of new credit threatens to interrupt the production and consumption of goods, the real physical economy. We see too much debt in some hands and lots of owned money in other hands. The people who own the money do not want to consume it all so half the people are cash rich and half are cash starved and we have a credit crisis or debt crisis, which is the same thing seen from opposite perspectives. There is no 'effective demand' for new economic output so the economy crashes even though everyone still wants to work, earn and consume.

I have seen half-joking SA comments that the government should issue every adult American a debit card with a $50,000 credit balance. Essentially this is what is required. People would use the money to buy stuff, payout their debts, and deposit some as savings in banks who would relend it. This would get the money system circulating again. It would be a mistake to make the entire balance available all at once. Maybe $1000 per month would be better. Mosler describes the economics of this kind of move so I'll refer you to him to see how this would play out.

Jan 13 08:29 AM

[benevolent ...:]

Mr. Templeton,
Could you please sight your sources for the above graphs? According to David Walker, former head of the General Accountability Office (GAO), the future obligations of medicare are 3 times higher for 2020 and current federal debt is at least 90% of GDP ( the Feds contribution is becoming a greater percentage of that GDP thereby nonproductive or socialized GDP) than you have shown.

Jan 13 10:40 AM

[David I. Te...:]

The source is noted in the "Source" footnote at the end of the article. The link will take you to the St. Louis Federal Reserve site and the longer article.

www.stlouisfed.org/pub...

David


On Jan 13 10:40 AM benevolent dictator wrote:

> Mr. Templeton,
> Could you please sight your sources for the above graphs? According
> to David Walker, former head of the General Accountability Office
> (seekingalpha.com/symbo...), the future obligations of medicare
> are 3 times higher for 2020 and current federal debt is at least
> 90% of GDP ( the Feds contribution is becoming a greater percentage
> of that GDP thereby nonproductive or socialized GDP) than you have
> shown.

Jan 14 07:55 AM