Monday, April 4, 2011

The Hidden American $100 Trillion Debt Problem

Now that the United States is just days away from hitting the statutory debt limit imposed by the debt ceiling, I thought I'd take a quick look at a summary of the issue of the looming "debt bomb" poised to hit the system over the coming decade.  We've all heard about the $14.3 trillion debt but what if that pile of "merde" was just 12 percent of America's total debt?  Keep reading!

The CATO Institute, a libertarian think-tank based in Washington, D.C. published a Policy Analysis entitled "Bankrupt - Entitlements and the Federal Budget" at the end of March 2011.  In this analysis the author, Michael Tanner, looks at the bigger fiscal nightmare facing the United States - yes, the one unimaginably bigger than the $14.3 trillion debt.  Mr. Tanner considers the unfunded liabilities of entitlement programs including Social Security, Medicaid and Medicare; when all three of these liabilities are added to the debt, it approaches the $119.5 trillion mark.  That's $385,000 for every man, woman and child in America.

Federal government spending under the Obama and Bush 2 Administrations has doubled over the past 10 years.  By 2025, the debt excluding the unfunded entitlement program liabilities will exceed 100 percent of GDP and by 2035, that could rise to 180 percent of GDP.  Over the past decade, federal spending on discretionary domestic items has risen by 120 percent and defense spending has risen by 135 percent.  While those numbers are alarming, they pale in comparison to what will be required to fund social entitlement programs.

Mounting deficits over the past decade have compounded the American sovereign debt problem.  Federal government deficits over the past 3 years have reached record levels.  Here is a graph showing the deficit for the past 50 years as a percentage of GDP:

Many observers claim that recent increases in the deficit are due, in large part, to two factors; the Bush tax cuts and the wars in Afghanistan and Iraq.  In the case of the tax cuts, the author notes that at least some portion of the tax cut can pay for itself because of changes in personal and business expenditures resulting from the reductions in taxes.  In the case of defense spending, the $1.1 trillion spent on two wars since 2001 represents only a small fraction of the total amount of the deficit.  Here is a graph showing the impact of both the tax cuts and increased defense spending on the deficit:

Over the past 40 years, federal spending has averaged about 21 percent of GDP and revenues have averaged roughly 18 percent.  This leaves a long-term shortfall of 3 percent of GDP on average.  By 2009 - 2010, tax revenues were only 14.9 percent of GDP, the lowest since 1950.  While some of this can be attributed to the tax cuts, a portion of lower tax revenues is related to the slowdown in the economy during the Great Recession.  The Congressional Budget Office estimates that the tax cuts probably accounted for about 2 percentage points of the drop in tax revenue meaning that had the tax cuts not been in place, the deficit would have been 8 percent of GDP rather than 10 percent, not a huge difference.

On the other side of the ledger, as I noted earlier, spending has increased massively under both the Bush 2 and Obama administrations.  By 2010, federal government spending reached 24 percent of GDP, down from 25 percent in 2009 but still the two highest spending years since the end of World War II.

When you bring the spending and revenue sides together, even if revenues were to rise to their normal 18 percent of GDP, with spending at 24 percent of GDP, the budget deficit will still be equal to 6 percent of GDP.  This tells us that the blame for the deficit lies at the feet of overspending not undertaxing.  As well, note that none of these calculations account for future rises in interest owing on the debt, resulting from both rising interest rates and rising overall debt level.

The overall debt level of the government is front page news, especially now that the United States is within days of reaching its debt ceiling of $14.3 trillion.  The government classifies its debt in two ways; the debt held by the public and intergovernmental debt.  Debt held by the public consists of United States government securities owned by individual investors, foreign governments and other entities outside of the federal government itself.  At the end of January 2011, the debt held by the public exceeded $9.46 trillion or roughly 60 percent of GDP.  The interest on this debt must be paid in cash meaning that the burden falls on taxpayers to cover these interest charges with their tax dollars.  Intergovernmental debt is the debt that the federal government owes itself; the Social Security Trust Fund and Medicare Trust Fund are the two largest holders of intergovernmental debt with a total debt of $2.972 trillion.  While this debt does not have to be repaid at any particular point in time, it does ultimately have to be redeemed and the cost of the debt must be reflected in the government's books according to accepted accounting principles.

There is a third category of government indebtedness that is not widely discussed.  The author terms this debt "implicit debt" and it represents the unfunded future obligations of entitlement programs like Social Security, Medicare and Medicaid.  This is money that the government will ultimately owe taxpayers.  As it stands, the government has a future obligation to pay these benefits to American citizens under current law and, unless Congress acts to change the payment of these benefits, for example by reducing Social Security payments to individuals, the promises show up as debt on the federal government's ledger.

Currently, Social Securities unfunded obligations are more than $16.1 trillion and Medicare's unfunded liabilities lie somewhere between $28.7 trillion (with the rather unrealistic spending reductions proposed by under the recent health care bill) and $89.3 trillion (without the reductions in spending from health care reform).  If we take the best-case scenario and add the $14.3 trillion debt to the unfunded $16.1 trillion Social Security and $28.7 trillion unfunded Medicare obligations, the total debt reaches $59.1 trillion or 412 percent of GDP.  In the worst-case scenario where Medicare savings are not achieved, the debt comes in at a staggering $119.5 trillion or 900 percent of GDP.

The author estimates that by 2050, Social Security, Medicare and Medicaid will consume 18.4 percent of GDP and, if you recall, normal government revenue is approximately 18 percent of GDP meaning that these three programs will consume all government revenue in 40 short years.  If we add in the interest on the debt, government spending rises to 31.9 percent of GDP meaning that a tax hike of 14 percent of GDP will not enable the government to fund any programs beyond Social Security, Medicare, Medicaid and interest payments on the debt as shown here:

As I noted before, all of these projections assume that interest on government debt remains at its current level of 2.2 percent, well below the average rate of 5.7 percent over the past 20 years.  If interest rates were to return to normal historical levels, an additional $557 billion would be added to interest costs in the year 2015 alone.  Working against the current low interest rate environment could be a perception among debt holders that United States Treasuries are an increasingly risky investment requiring a greater return (i.e. higher interest paid on the Treasuries to offset the perception of risk).  This situation becomes extremely dangerous because there can be no certainty whether interest rates will rise sharply as they did in the period from 1979 to 1981 or slowly as in the recent past.  The Congressional Budget Office warns that a spike in interest rates similar to 1979 would create huge losses in the world's bond markets and could lead to the failure of financial institutions similar to what we experienced at the outset of the Great Recession in 2008.

While government spending is necessary, too much of a good thing can stunt economic growth.  Mr. Tanner states that governments must provide a certain level of basic services such as infrastructure, defense and security and that if governments spent nothing, there would be much less economic growth.  However, where governments spend too much, the disincentive of higher taxes and the crowding out of corporate debt (where a dollar borrowed by the government is no longer available for private use) can stunt economic growth.  Currently, federal government spending consumes about 24 percent of GDP and state and local governments spend between 10 and 15 percent of GDP.  If there is no change in the level of federal government spending, projections show that by 2050, federal government spending will reach 46 percent of GDP resulting in all levels of government consuming around 60 percent of GDP.

Here is a graph showing the mounting problem of federal government spending over the next 70 years:

Here's what one senior Chinese banking official, Li Daokui, had to say about the United States debt situation:

But we should be clear in our minds that the fiscal situation in the United States is much worse than in Europe. In one or two years, when the European debt situation stabilizes, attention of financial markets will definitely shift to the United States. At that time, U.S. Treasury bonds and the dollar will experience considerable declines.”

We know that when governments can continuously borrow and spend, there is no obligation for them to show fiscal discipline and restrain their spending.  They know that the taxpayer will always be waiting in the background, wallet in hand.

According to a study entitled "Guessing the Trigger Point for a U.S. Debt Crisis" written by economist Arnold Kling:

" would appear to be quite likely that the United States will experience a debt crisis within the next two decades, unless the path for fiscal policy changes from what is projected by the Congressional Budget Office. However, international capital markets continue to treat U.S. Treasury debt as a fairly safe asset. One way to interpret this phenomenon is that investors expect the United States to take steps to get its fiscal house in order.

The assumption that the United States will have the political will to stabilize its fiscal position is based more on hope than on recent experience. If the political process continues to enlarge the government’s commitments to spend in the future, investor expectations will change at some point. That change in market perception is likely to be swift and severe."

Let's hope that Mr. Kling's assumption is correct and that the world’s markets continue to grant special treatment to the debt issued by the United States and that the government makes real efforts to get its fiscal house in order…but I wouldn’t count on it.  With the looming issue of a $100 trillion unfunded entitlement program issue lurking in the background, the debt problem is certain to become more complex as the years pass.  My suspicion is that if and when the United States debt reaches even 400 percent of GDP, the world will be a far different place and that the American way of life will have changed forever.  Meaningful changes to entitlement programs will have to take place sooner rather than later if future generations of Americans are to dodge this loudly ticking “debt bomb”.


  1. APJ:
    As you know, intragovernmental debt is made up of about 20 trust funds. One of those trust funds is for federal employees' retirement. This trust fund has been handled similarly to Social Security's. Unlike state employees' retirement funds that have reserves which are liquidated to pay benefits, the federal employees' retirement fund has no store of wealth in its "reserves." To tap the reserves, new money must be raised, as if the reserve did not exist. Benefits are paid like Medicaid, out of general revenues and debt.
    Federal employees' retirement contributions are considered exchange transactions by the FASAB(the accounting advisor for the federal government).
    This means employees willingly take lower salaries in lieu of later retirement benefits.
    This is a liability of the federal government, and is valuated at $5 trillion, on the balance sheet, along with debt held by the public.
    Social Security contributions, on the other hand, are nonexchange transactions. This means money is forcefully collected, and the government pays the benefits, only out of the goodness of its heart.
    Don Levit

  2. Thanks for the background information Don.

  3. There is no federal debt problem. This is a manufactured problem being pushed by people who want smaller government for ideological reasons, not fiscal ones.

    The federal debt is not the same as personal debt. All of our “debt” is in the forum of dollars, which we have the sole ability to produce. Greece does not control its currency which is why their government debt matters, the same goes for the states. If you want a more accurate similarity, look at Japan, whose federal debt is over 220% GDP (~4x the size of ours) and growing with no end it sight. They still have no problems with inflation, neither do us.

    Remember, all currency is “debt.” All new money is created by the fed, the banks via fractional reserve, or the federal government by deficit spending. All this money created by these three processes is given out as loans, with interest. Thus if all debt was repaid in this country (plus interest), there would be not be enough money to cover all the liabilities debts.

    So, the federal government created from thin air, T-securities, which it exchanged for dollars it previously had created from thin air. To eliminate this misnamed “debt” merely requires the reverse exchange.

    Our economy is still weak. We must continue to spend on infrastructure, research, and education to ensure we fully recover and stay the worlds leading economy.

  4. I have no doubt that as bad as the debt situations are in Europe and Japan, that America's is far, far worse. The only difference is that the US media and government are far more adept at covering the problem and pointing the finger at other nations. I

  5. This is great, and somewhat alarming, insight.

    But, what is a rational investor to do? I realize you're not in the business of giving investment advice but if one truly believes that the world will lose confidence in the US dollar, does that mean American citizens should start buying Euros today? or foreign stocks?

  6. Engineer. For sure. Listen to Peter Schiff on how Americans can protect themselves. gold and silver and foreign equities.


  7. Exactly. I could not have said it better myself.

  8. @ TV hatic:
    Comparing Japan's situation to the US situation doesn't work. Japan owes most of it's debt to private citizens through the state owned deposit corporation. The interest paid on the debt is reinvested back into the nation via the bank profits; the US federal reserve is a private bank, and many of the debts owed by the US are to foreign countries (i.e. China).

    Why the Japanese Government Can Afford to Rebuild,%20It%20Owns%20the%20Largest%20Depository%20Bank%20in%20the%20World%20By%20Ellen%20Brown.htm


    Japan's Lost Decade

  9. You say the problem isn't under-taxing, you think those multi-nationals like Google with their income shifting isn't a problem? In a Bloomberg article it has these tax cheats with a 2.4% tax rate. And lets stake a better look at the welfare warfare Defense budget. Defense spending was listed at 250+ billion a year before those bogus attacks on 9,11. Now when you include everything, like the wars, the war on terror etc. etc. they're burning 1+ trillion a year. If you get rid of this bloated Defense budget, get rid of the tax cheats, cut all of these crony contracts that these corrupt politicians hand their friends, eliminate the fraud and wasteful programs, and start creating jobs in this country again, our problems will be over. But no, they're going to continue funding their interests till there's nothing left. These criminals are handing countries like Israel and Pakistan billions while gutting people at home. They're not working for the people of this country, they're working for themselves. You want to cut Social Security, which will be the only thing left old people will have to live on, pay back all the money that was stolen from people first.

  10. @mysko69 - Brilliantly said.

  11. I, for one, trust unbiased sources like the CATO Institute, Chinese banking officials, and libertarian think tanks for my policy analysis.

  12. Peter Schiff? LOL!!!

  13. I think we can all guess what will happen now, but i doubt it will be china controlling the states. The U.S government will put high pressure on states such as Texas to help lessen their debts. If i were Texas (figuratively speaking) i would say fuck you, and start a civil war to split away, its not MY fault Washington is a bunch of over payed idiots. The upper US is in no condition to fight a civil war and I bet any state trying to separate would be able to leave with little resistance. Any and all armed forced out of state would likely be called home at this point, but will they fight for their country, or their home?
    Now, as if this isn't bad enough, everyone who has lent the U.S money is probably getting fairly impatient. They will be forced to make trades likely involving weaponry or w.e else the states has to offer. This is only postponing the inevitable however, eventually some country will demand land from the U.S as payment, the U.S will say FUCK YOU WE HAVE AN ARMY, or at least they had an army... before their civil war. The U.S will threaten Nuclear war, but its too late, we are not the only country with nukes, and most of the other countries with nukes we owe money too. The UN will hold a secret meeting, excluding the U.S, and talk about the threat of nuclear war as it concerns everyone. Covert teams will be sent into the states to disarm any and all nuclear weapons, and assuming all goes well we will then be invaded and the map of North America will look like Europe. Every country carving out its own chunk of land. World War 3. The "great power" of the 21st century gone like all other "great powers" before it.

  14. Would I be terribly out of line for suggesting this is mostly a non-issue? A tax intake of roughly equivalent to 18% of GDP is modest indeed. While it may go against natural inclinations prevalent in the US, a considerable tax hike is the only answer. I wonder what the fiscal picture would look like with, say, a 30-35% tax intake (as would be more in line with other developed nations). The notion that higher taxes discourage economic growth is nonsensical. Take a look at countries like Sweden(47.2%), Germany (37%), Denmark (48.2%) and The Netherlands (39.1%). It never ceases to amaze me that the highest taxed countries as a rule also seem to been the most prosperous and developed ones. Hence, I wonder if any correlation might possibly exist?!

  15. Debt is equivalant to devalution of the dollar.

    Debt does matter! Are you people crazy?

    Debt is created by printing more money which devalues the dollar instantly.

    If you take into account all disclosed or known debt this leaves us already at approximately 98% devaluation.

    Even if the hidden debt was as large as the number of particles in the universe, (10^80), the total further devaluation would always be less that 2%.

    The banks no longer have the option to print money to devalue the dollar to generate wealth.

    That is while the economy will flatline and we will have to resort to socialism to insure people at least get what they NEED.

    Einstein predicted the world would have to unite under a socialized sytem because of lack of resources and to ensure basic human rights.

  16. Money does not have an intrinsic value.

    Money only has an intrinsic devalue.