Tuesday, October 15, 2013

America's Looming Unsolvable Debt Crisis

Updated October 30, 2013

With the debt ceiling crisis "behind us", at least for the time being, I'd like to present a few graphs that show how America's federal debt compares to other nations and how the situation is likely to worsen as the years pass despite the political platitudes that politicians are so prone to offer us.

Let's start with two graphs from the Congressional Research Service showing how the level of the U.S. sovereign debt compares to other advanced nations as a percentage of GDP.  First up, gross debt as a percentage of GDP:

In this measure, the United States comes in sixth place with gross government debt of just over 100 percent of GDP, behind Japan, Greece, Italy, Portugal and Ireland, four of the five PIIGS nations that were of such a concern a couple of years back.

Here's a graph showing net debt as a percentage of GDP for the same advanced nations:

Net debt subtracts the government's total financial assets from its total financial liabilities or debts.  Once again, the United States comes in sixth place with a net debt-to-GDP ratio of 80 percent, behind Greece, Japan, Portugal, Italy and Ireland.

Unfortunately, as though it's not bad enough now, the debt situation is only going to get worse for all developed economies.  In most cases, there will be a sharp rise in the ratio of old-age population to working-age population; this will push up costs for health care and other entitlement programs, unfunded and underfunded liabilities that will arise from an aging population.

Let's start this section by looking at United States net federal government outlays as a percentage of GDP:

Currently, net outlays for Washington are just under 22 percent of GDP, just off the post-World War II highs of 24.4 percent in 2009 as the economy circled the white porcelain bowl.  Federal government net spending as a percentage of GDP has risen steadily from between 10 and 15 percent of GDP since the late 1940s a situation that will continue as the population ages.

Now, let's go to a 2010 paper by Stephen Cecchetti et al from the Bank for International Settlements entitled "The future of public debt: prospects and implications".  Here is a graph from the paper showing the ratio of old-age population to working-age population for some of the world's larger economies between 1960 and 2050:

Currently in the United States, the ratio between the old-age population and the working-age population is around 0.20.  By 2050, this is estimated to rise to around 0.38 meaning that there will be twice as many seniors per worker as there are now.  That means that age-related government expenditures will rise for the United States as well as other advanced economies as shown here:

In order to cover these additional age-related costs, the United States will have to improve its budgetary balance (excluding interest payments) by 6.9 percent of GDP, the highest level among the key nations in the study, excluding Greece.

You will notice that the authors' calculations exclude interest owing on the debt.  Here's what happens to projected interest payments as a percentage of GDP (United States in purple):

Interest payments will rise from under 5 percent of GDP now to about 23 percent of GDP by 2040.  Remember, this is on top of rising age-related costs as I noted above.  What we end up with is a worst case scenario where interest owing on the debt is rising at the same time as age-related expenditures are increasing.

To stabilize the U.S. debt-to-GDP level at the level last seen in 2007 (the pre-crisis level), over the next five years, the federal government will have to run a primary surplus of 8.1 percent of GDP, over the next 10 years, the primary surplus will have to be 4.3 percent of GDP and over the next 20 years, the primary surplus will have to be 2.4 percent of GDP.

To put these numbers into perspective and just in case you were curious, the "fiscal gap" described by Lawrence Kotlikoff is nothing short of sphincter puckering.  In a recent interview, Dr. Kotlikoff defines the difference between the governments outlays (liabilities) and its receipts (assets) as the "fiscal gap" which currently amounts to about 10 percent of the present value of the future GDP.  About 60 percent of this gap is related to spending on Medicare, Medicaid, health exchanges and employer-paid, tax exempt healthcare premiums.  Dr. Kotlikoff estimates that, generational accounting suggests that the fiscal gap is a stunning $200 trillion rather than the oft-cited $16.4 trillion in current debt.  To come up with $200 trillion in present value, a combination of tax hikes and spending cuts amounting to 10 percent of GDP would have to be implemented immediately and indefinitely.  If spending cuts alone were used, a permanent 36 percent cut in all non-interest spending would have to take place.  If tax hikes alone were used, a permanent 55 percent increase in all federal taxes would have to take place.

To summarize, it's obvious that the current situation in the Senate and Congress is, at most, going to put a temporary bandaid on a long-term nightmarish debt problem that is likely not fixable by anyone from any political party unless someone is willing to inflict a great deal of pain on voters and voters find themselves willing to make huge personal sacrifices.    When you look at these numbers and see that decades worth of surpluses are necessary to meet the long-term shortfall related to aging and interest payments, it is quite apparent that the situation is futile because we can't even get agreement on a single year's budget.   Unfortunately, there are very, very few in Washington that spend even one second of their day thinking about anything beyond the next election cycle.  

On the other hand, perhaps we are better off believing in the illusion that a debt-ceiling agreement will actually accomplish something meaningful rather than facing the painful reality of the looming fiscal gap.  In any case, it's quite apparent that any debt ceiling deal that is reached by the Republicans and Democrats is just putting a bandaid on a fiscal hemorrhage. 


  1. This should be required reading by every representative and senator.

  2. ok Mr. Political Junkie you have found the problem. What is going to happen in your opinion (most likely things that will happen in next 5, 10, 25 years?) Next what is a realistic way to deal with this problem? Cleary raising taxes 55% and or cutting 35% across the board on federal spending isnt likely.

  3. we let the paper money Ponzi scheme collapse!

  4. Debt crisis will not be solved if a solid economic reform will not be implemented.