Wednesday, May 17, 2006

National debt
"Each year since 1969, Congress has spent more money than its income. The Treasury Department has to borrow money to meet Congress's appropriations. The total borrowed is more than $8,000,000,000,000 and growing. Even when government officials claim to have a surplus, they still spend more than they get in. We pay interest on that huge debt."

"In Fiscal Year 2005, the U. S. Government spent $352 Billion of your money on interest payments* to the holders of the National Debt. Compare that to NASA at $15 Billion, Education at $61 Billion, and Department of Transportation at $56 Billion. For the current FY06, the running total is $213 billion spent on interest payments!"

"The interest expense paid on the National Debt is the third largest expense in the federal budget. Only Defense and income redistribution (The Departments of Health and Human Services, HUD, and Agriculture (food stamps)) are higher. Do you have "Compassion" for the lower income earners? (You may note that social spending is the largest item in our federal budget. (Anyone complaining about the run-up of the deficit, should note that almost all of it is going to social spending)."

Nat'l Debt 1950-2005:

Tax can be good:
Who do we owe this money to?

We owe it to the people and entities that have bought or received U. S. debt instruments, such as Savings Bonds, Treasury Notes or Treasury Bills.
That includes:

* Average folks like us
* Large and small corporations
* Banks
* Pension funds
* Insurance companies
* Various U. S. government entities such as the Social Security Trust Fund
* State and local government entities
* Foreign investors
* Foreign corporations
* Foreign governments
* For more information:
The Public Debt Online (U. S. Treasury, Department of the Public Debt)
Treasury Bulletin (U. S. Treasury, Financial Management Service)

Why do we owe it?

We have this debt because our government (that's you & me) spends more than it collects in taxes. The solutions are:

* Spend less. That's a lot harder than it sounds; most government spending that could be cut is relatively minor. The things that cannot be cut (or would be extremely difficult to cut) are huge.
* Tax more. If we can't (or won't) cut spending, it's our only choice.

Why can't we just cancel the debt?

We can't cancel it (default) because real people would be hurt—lots of real people, very badly hurt.

* Some people say, "It's not really a debt, because we owe it to ourselves." It would be closer to the truth to say we owe it to each other—and it isn't owed equally to all Americans.
* Defaulting on the debt would do great damage to many pension funds, life insurance companies, banks, state, county and municipal governments, and foreign governments.
* When you—or your parents—or your grandparents are ready to retire, and cash in life insurance policies or pension funds, the money must be there. In fact that happens every day. But we don't have the money to pay what's owed, so we borrow more, further adding to the debt.
* A huge amount of the debt is owed to the Social Security Trust Fund. When, in a few years, that fund goes from positive to negative cash flow, the money has to be available. If it hasn't been repaid to the fund at that time, it will have to be raised through additional borrowing, or additional taxation.
* Internationally, the consequences of a default are hard to imagine. World trade as we know it is dependent on stable financial structures and international trust. The U.S. economy is an immense part of the world's financial structure. The world may not trust us politically, but if they couldn't trust us financially, the impact on the world economy, and on our own, would surely be catastrophic.

Why should I have to pay for incompetent government spending, generations ago?

We have to pay the government's debt, because the government is us.

* Most of the past spending was done for us—it really was.
* We benefited from the low taxation that left money in our pockets instead of paying for our government's expenses as we went along.
* Most of that debt was not incurred generations ago. The biggest chunks were incurred as a result of tax cuts in the early 1980s, and in the early 2000s.
* The consequences of default are unthinkable. Our economy, and the world economy would be severely damaged, perhaps destroyed.

What kind of debt is this, exactly?

The instruments of the debt are things like Savings Bonds, Treasury Notes or Treasury Bills.

* When your grandmother bought you a U. S. Savings Bond, she was actually loaning money to the U. S. Government. If you never cashed in that bond, the Government still owes you the money, with interest.
* When your bank needs to invest the money you've deposited in a savings account, they're likely to invest some of it in government securities—the safest investment available to them. In effect, they're loaning your money to the government, which will pay it back with interest, part of which your bank will pay to you when you withdraw the funds.
* When your city government has collected a bunch of sales tax during December, and won't be spending it until they fill potholes in your street in April, they may buy short-term government bonds with the money. Yep—they loan it to the government, and get it repaid with interest when they need it. If they don't buy the bonds directly, they may put the money in a bank. Guess what the bank does with the funds? Uh huh.

Why does the government keep borrowing, when they know they can't pay it back?

We have to borrow, every month.

* Every day, people and institutions cash in government securities. They must be paid. Since we haven't had a surplus since 2001, we have no money to pay them. The only way we can pay them is to borrow more, by selling more securities.
* We're spending more than ever before, for military incursions, for increasingly expensive health care, and for interest on the debt. Our taxes aren't high enough to finance that spending, so we must borrow.

Why is our government pouring money into other countries as aid?

There are several variations on this question, targeting spending on such things as foreign aid, welfare, or congressional salaries. Everyone has a government expenditure he or she loves to hate. The problem is that most of those expenditures are so small that even their elimination would have no significant impact on the deficit.

* Put on a personal level, reducing such expenditures as foreign aid or congressional salaries would save each working American a few cents or a few dollars per year.
* There are really only three expenditures big enough that they have great impact on the budget; they are health care, defense spending and interest on the debt.
* Interest is a single item; the others are categories. Interest on the debt is the biggest single item in the federal budget. If we had no debt, and therefore no interest, our deficits would be easily manageable in the short term. In the late nineties, interest on the debt actually accounted for the entire deficit. The only way we can reduce interest is to reduce the debt.
* Our expenditures for health care are immense, including active and retired military and their dependents, active and retired civilian government employees and their dependents, and Medicare. None of the plans that have been presented on the main political stage in recent years even pretend to reduce expenditures for health care—they only nibble around the edges of the problem, if that.
* It's pretty hard to talk about defense reductions in the midst of a major military incursion.

How can we get out of this mess?

The solutions are:

* Spend less. That's a lot harder than it sounds; most government spending that could be cut is relatively minor. The things that cannot be cut (or would be extremely difficult to cut) are huge.
* Tax more. If we can't—or won't—cut spending, it's our only choice.
* Realistically, we have to do both. In fiscal 2004, the deficit equaled 17.5% of spending. I can't conceive that growth in the economy is going to amount to 17.5% anytime soon. I can't imagine that we can reduce actual spending by 17.5%. So taxation has to be a part of this.
* If we are really ready to sacrifice significant spending programs, perhaps we could cut overall spending by as much as 8% or 9%. But think what that means! The average increase in spending over the past 5 years has been almost 5%. If inflation in the next few years averages 3%, and we stop the increases in spending, and we reduce spending by a real 8%, that totals 16%!! What do you think? Is that 8% reduction realistic? Nah, 1% or 2% is more realistic.
* So we have to increase taxes—we have no choice. Won't that hurt our economy? Probably.

Won't more tax cuts stimulate the economy enough to reduce the deficit?

The short answer is: NO!

* The only tax cut I know of that ever actually increased revenues was in the early 1960s. The situation then was vastly different from now. The highest tax rate in the fifties was actually over 90%. The early sixties tax cuts restructured taxation in fundamental ways, and did indeed stimulate the economy. We were also in the full bloom of post-war recovery. And the tax cut wasn't as big as it sounded, either. Very little income had ever actually been taxed at those enormous rates because most large incomes were well sheltered from extreme taxation.
* The tax cuts of the 1980s and the early 2000s created huge increases in the deficits and the debt.
* There is no room for significant tax cuts now, because even short term deficit increases could be deadly.
* There's another problem with this question as it's asked: it talks of reducing the deficit. Deficit reduction isn't what we need; that only slows the disaster. We must eliminate the deficit. Only when we replace the deficit with surplus, can we begin to reduce the debt. Only debt reduction will reduce the tremendous cost of interest we are paying.

What happens if nothing changes?

This answer isn't as simple as it might seem.

* In the very short term, very little happens if we don't address the problem. That is in fact part of the problem, because it helps us remain complacent. In the short term, your taxes won't go up, because a lot of politicians are dead set against tax increases. But larger and larger portions of your tax money will go to pay interest on the debt, rather than current expenses.
* Interest rates will continue to rise. The government is a huge borrower, getting bigger every month. The amount we borrow impacts interest rates significantly.
* Rising interest rates will increase deficits.
* Increased deficits necessarily increase the debt.
* Increased debt means higher interest payments.
* Higher interest payments create higher deficits.
* As this cycle continues, interest rates must rise further.
* The problem worsens exponentially.
* At some point there is a critical mass effect; the government's appetite for borrowing will exceed the world economy's supply. Then interest rates will soar, and the entire house of cards may well collapse—that's financial collapse—worldwide.
* If that collapse can somehow be avoided, at the very least, we will all have to pay sharply higher taxes than we have ever paid, and for a very long time, to restore worldwide financial stability.

Why do interest rates fluctuate so wildy?

OK, this is a bit complicated.

If you look every month at the interest paid on the debt, you'll see that it is much higher in some months than in others, even though the size of the debt changed very little. The explanation is in the way the Treasury Department sells and redeems securities. They sell securities several times every month. Some securities mature in as little as four weeks, others in as long as thirty years Every month, some securities mature and are redeemed. Some of those will have been sold in the previous month, but some were sold thirty years ago.

Study Table PDO-1, Maturity Schedules of Interest bearing Securities, which is linked from the Treasury Bulletin website. It lists all the market offerings of securities that are still outstanding, and their issue dates and interest rates —all sorted by the dates they mature. Notice that the interest rates on individual lots of securities can be as low as 1.5%, and as high as 14%. Refer also to the Monthly Interest Rate Certification. It shows the interest rates Treasury has recently paid, and expects to pay in the immediate future, on new security offerings. In September '05, these rates ranged from 3.5% to 4.625%.

Each month, some old securities mature, and new securities are sold. If we redeem a lot of old 13% and 14% securities, we replace them with 3.5% and 4.5% securities, and our interest payments go down. On the other hand, if we redeem a bunch of 1.5% and 2% securities, replacing those at the current rates, our interest payments rise.

As obscure as this seems, it is actually extremely important. The chief reason that our deficit fell so dramatically in the late '90s is that we replaced a lot of old, very high-interest debt from the '70s and early '80s, with much lower interest debt. Even though the amount of debt was still increasing, the overall interest payments were reduced. We're still retiring some of that high-interest debt, but there's a lot less of it than there once was. When it's gone, our interest payments will begin to rise, reflecting the rising interest we are paying on new debt. When that happens, the deficit will rise even faster than it has been rising.

Reaganific! Go for growth and skip the debt:

1 comment:

Scooter said...

Middle Ear,

Thank you for your very informative post! It amazes me that more people do not wake up and realize that our national deficit will eventually come back to haunt us. This is an issue that has grown little in awareness, yet few seem obligated to fix. Spread your message loud and clear. You have one supporter in the cause!