Raising the Debt Ceiling - Again

Apparently, a bazooka wasn’t enough. Last summer, that is what then-Treasury Secretary Henry Paulson asked for when he made his case for sweeping financial powers. Instead, Congress gave him a nuke, and apparently that wasn’t enough either. Making the jump from completely absurd to the absolutely ridiculous, Timothy Geithner became the latest in a long line of Treasury Chiefs to run to Congress to ask for an increase in the nation’s debt ceiling.

The fact that he is asking for the increase should not be a surprise to anyone given the massive deficits already racked up over the past 18 months. What would be laughable if it weren’t so serious, however, were the comments made in his request letter to Congress.

"It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations,"

How exactly does digging your hole even deeper inspire confidence? How does borrowing nearly 50 cents of every dollar you spend inspire confidence? How can anyone with two bits of common sense to rub together take this as anything less than an overt devaluation of the Dollar? Yet his request was taken in a ‘business as usual’ manner by the media. Of course, this could be due to the fact that in our age of borrow and spend, these requests are becoming more and more commonplace. Perhaps this is one of the reasons people are so annoyed these days?

Debt as a percentage of GDP

This is one of the ways that the overall debts of one nation can be compared to those of another. In 2009, US public debt will be approximately 90% of GDP. It will quickly approach and surpass 100% of GDP in the near future. The chart below, sourced from FY 1020 historical budget tables on pp. 127-128, outlines in dramatic detail the accumulation of debt.

But the chart, unfortunately, only tells a very small portion of the story. First of all, there are some rather interesting assumptions being made here:

1) The chart deals in gross GDP, which is actually better for the discussion since we don’t have to worry about the deflator (GDP Price Index) clouding the initial discussion.

2) The chart assumes that 2009 GDP will be $14,233.96 billion. Given that 2008 GDP was $14,441.40 billion, this constitutes a total drop in GDP of $207.44 billion or 1.44%. This seems a bit shallow considering that to date gross GDP is already 1.38% below that of Q4 2008. That puts the annual pace of the contraction at 2.76%.

3) 2014 estimates place a national public debt of $18,350 billion at 99.9 percent of GDP. This implies a GDP of $18,368.4 billion. This assumes an immediate return to 5% GDP growth per year for each of the 5 years estimated.

Let’s say for example that the rate of ‘recovery’ is more realistic at 2.5% (a rather charitable assumption given the current state of affairs). Suddenly by 2014, the public debt is a whopping 113% of GDP instead of the 99.9% assumed. If we take it a step further and set the GDP growth to 1%/year, which is probably rather close to a best-case scenario, then the $18,350 billion of public debt in 2014 becomes 127% of GDP.

So the big question is where did the assumption of a return to 5% growth come from? Let us take a look at a popular, but discontinued series – M3. Discontinued, if you remember, to save the taxpayers money.

If you do a little smoothing on the data, you will find that M3 generally rose at a rate of very close to 5% per annum. From a monetarist’s perspective, THIS is the real rate of inflation, not what is displayed in the CPI, the GDP price index or other hedonically adjusted numbers. I think that most people are able to understand the implications of discounting annual GDP growth by 5% every single year. Just to make the point, it is included below:

If you perform the same smoothing on this data, amazingly, you’ll come up with almost the same 5% as above.

What this means is that since 1959, we have had almost no growth in real GDP over the period, but have gone into debt nearly eleven and a half trillion dollars to do it. Now many folks will nitpick about the fact that M3 growth should not be used to adjust GDP, but if you’re going to understand that inflation is an increase in the money supply, then you’d better discount your GDP by the growth in the money supply, not by some politically driven price index, which at best only measures one of the symptoms of actual inflation.

Given the fact that we have such a dismal record of turning our borrowed dollars into anything productive, it would make sense to prohibit the government from borrowing any more money on the behalf of the people. Surely Secretary Geithner is aware of this awful record.

But it gets even better.

"Congress has never failed to raise the debt limit when necessary,"

I would contend that in never failing to increase the debt ceiling that Congress has done exactly that - failed.

Comments

[markfl:]

I am of the opinion that there is simply no political will whatsoever to cut the federal deficit, which ultimately means the debt ceiling will be raised again and again. We may face a scenario that, at the end of 2010, the economy has grown for 6 quarters (albeit weakly). The argument will be made that the economy is still too weak, because unemployment is still too high.

Using this argument, the economy is always too weak. The deficit can't be cut during contraction. During expansion, it can't be cut because the economy is fragile. Once it stops being "fragile" it can't be cut because we don't want to risk a recession. Such has been the cycle for 30 years.

Aug 16 05:06 AM

[Steven Hansen:]

Andy, you did a great job and this is an excellent article for sunday contemplation.

from a logic point of view, i have a little difficulty believing we had no GDP growth since 1959. from observation, i would question if there has been any growth since 1990 (give or take).

but this should not detract from the thrust of your article on debt and real gdp growth to public debt ratios.

Aug 16 05:12 AM

[Dave Wrixon:]

The problem is that GDP has been sustained by drastically increasing Public Spending.

How is measuring Public Debt as a Ratio of Public Spending in anyway useful, because that is to a large extent what is going on with these figures? Does increased Public Spending actually underwrite the Public Debt is some way?

No, the truth is that the original purpose of comparing debt with GDP was because GDP was taken as a measure of the revenue potential of the Government. The bigger GDP the bigger the potential to collect Tax. If the bit of GDP that you are all responding to is in fact Government Spending this becomes a nonsense. Increasing spending only reduces your ability to pay off your debts, not increase them.

Harvard should be blown up and they should get in some Chinese Economist to educate America's future economists.

Aug 16 06:14 AM

[Bruce Krasting:]

We got pregnant on all of this last year. We are already in the second trimester. There is no turning back. This baby is going to term. The debt limit will be raised to whatever level is needed to see this pregnancy through.

There is no stopping or slowing this down now. We have spent a huge chunk of our 'wealth' on this. More must be spent. To reverse course now would mean that everything that has been done would be wasted. So that will not happen.

The only thing that can change the course of this is the markets. They are cooperating very nicely. 10 year bonds at 3.5% allow for all of this to happen. If they were at 5.5% all of this would stop. It is that small a difference.

So part of the increased debt limit will be a continuation of the monetization of the debt. Bernanke has said he will wind his purchases down. If that translates into higher interest rates this fall he will reverse his position and continue to monetize debt. He is pregnant too. He can't stop what he has started.

Those that think that we are returning to an economic landscape that looks like 2005 are wrong. We are going into uncharted waters. Seat belts on please.

Aug 16 09:04 AM

[Mike Kane:]

As I have said many times, the U.S. is being hanged at the end of a noose, and the hangman is our debt

Aug 16 03:52 PM

[Moon Kil Woong:]

National debt will never be reigned in except when government and the Fed realize that it is becoming increasingly hard to finance it. They should be realizing it about now, however they discovered quantitative easing. So now we have another few years of frivolous and unproductive years of government wastage to add to our long string of government mismanagement.

Aug 17 04:25 AM

[prudentinve...:]

Reminds me of MacBeth's, having "... so far waded in blood that returning were as tedious as going over....". He did indeed attempt to continue to go over, until he was eventually beheaded.


On Aug 16 09:04 AM Bruce Krasting wrote:

> We got pregnant on all of this last year. We are already in the second
> trimester. There is no turning back. This baby is going to term.
> The debt limit will be raised to whatever level is needed to see
> this pregnancy through.
>
> There is no stopping or slowing this down now. We have spent a huge
> chunk of our 'wealth' on this. More must be spent. To reverse course
> now would mean that everything that has been done would be wasted.
> So that will not happen.
>
> The only thing that can change the course of this is the markets.
> They are cooperating very nicely. 10 year bonds at 3.5% allow for
> all of this to happen. If they were at 5.5% all of this would stop.
> It is that small a difference.
>
> So part of the increased debt limit will be a continuation of the
> monetization of the debt. Bernanke has said he will wind his purchases
> down. If that translates into higher interest rates this fall he
> will reverse his position and continue to monetize debt. He is pregnant
> too. He can't stop what he has started.
>
> Those that think that we are returning to an economic landscape that
> looks like 2005 are wrong. We are going into uncharted waters. Seat
> belts on please.

Aug 17 09:25 AM

[Andy Sutton1:]

Hi Steve,
I guess another way of putting it is that the 'growth' has all been borrowed, meaning it wasn't produced vis a vis conventional means. Either way the whole situation makes Mr. Geithner's comments sound rather ludicrous. Although the commenter who mentioned the pregnancy has a good point; this thing is going forward no matter what - so does it really matter how bad it sounds?

Best,
Andy


On Aug 16 05:12 AM Steven Hansen wrote:

> Andy, you did a great job and this is an excellent article for sunday
> contemplation.
>
> from a logic point of view, i have a little difficulty believing
> we had no GDP growth since 1959. from observation, i would question
> if there has been any growth since 1990 (give or take).
>
> but this should not detract from the thrust of your article on debt
> and real gdp growth to public debt ratios.

Aug 17 02:42 PM

[RonS:]

In reply to markfl...the national debt has been cut twice in the last 50 years. The most recent time was during the last years of the Clinton Administration. In fact, if George Bush had not pushed through tax cuts, the Clinton debt reduction would have slowly reduced the debt to nothing.

Aug 17 09:18 PM

[Value Added:]

Andy, excellent two points you made: 1) M3 growth = true inflation rate; 2) GDP growth% - M3 growth% = true GDP change. It's interesting that MFN status was granted to China in 1980. From that point our GDP has languished as companies have made a mad dash for cheap labor, and sold our world-class technologies for pennies on the dollar.

Aug 17 09:25 PM

[whidbey:]

Wonderful post.

The spending and debt levels today are the offspring of a mindset that calls for public spending on the belief that private decisions will never be optional or even acceptable to raise the level of general welfare in the economy.

The effects of the Congressional binge have been to change the wealth and distribution consequences in society by their expenditures. In effect, the middle class tax payer has been decimated while the lower income groups have been little helped by government programs. Taxes have remained to high for wealth building by the middle class taxpayer, while the lower income groups pay not taxes as a rule, in fact get "credits" to redistribute GDP.

The higher income groups have done well under the tax cuts since 1978 - and - because they are massively more effective in spending equivalent dollars than government. The return on the investments of the high income group are very high. The difference is skill levels. So today the top 1% pay 40% of the federal taxes. This is a critical group who moved work overseas, not to just save money, but to escape unions, regulations, competition and receive favorable tax treatment of earnings. This group is valuable to any society since it is extraordinarily capable. The hacks stayed and did what they could with real estate.

The mess is largely a policy mess and the chances of undoing, short of a revolution, are very low indeed.

Aug 23 04:29 PM