Dale Franks’ QandO posts
In this podcast, Bruce, Michael, and Dale discuss concerns about Turkey, and the debt limit.
The direct link to the podcast can be found here.
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Mark Steyn, writing in Investors Business Daily, isn’t pulling any punches about what the near future holds for us if the Federal government keeps spending like there is no tomorrow. There won’t be.
[B]y 2020 just the interest payments on the debt will be larger than the U.S. military budget. That’s not paying down the debt, but merely staying current on the servicing — like when you get your MasterCard statement and you can’t afford to pay off any of what you borrowed but you can just about cover the monthly interest charge.
Except in this case the interest charge for U.S. taxpayers will be greater than the military budgets of China, Britain, France, Russia, Japan, Germany, Saudi Arabia, India, Italy, South Korea, Brazil, Canada, Australia, Spain, Turkey and Israel combined.
When interest payments consume about 20% of federal revenues, that means a fifth of your taxes are entirely wasted. Pious celebrities often simper that they’d be willing to pay more in taxes for better government services.
But a fifth of what you pay won’t be going to government services at all, unless by "government services" you mean the People’s Liberation Army of China, which will be entirely funded by U.S. taxpayers by about 2015…
And even those numbers presuppose interest rates will remain at their present historic low. Last week, the firm of Macroeconomic Advisors, one of the Obama administration’s favorite economic analysts, predicted that interest rates on 10-year U.S. Treasury notes would be just shy of 9% by 2021. If that number is right, there are two possibilities:
The Chinese will be able to quintuple the size of their armed forces and stick us with the tab. Or we’ll be living in a Mad Max theme park. I’d bet on the latter myself.
And we all know who’ll be running Bartertown.
Look, there’s no way to sugar-coat this. What’s coming isn’t gonna be pretty. Too many politically powerful groups have their fingers stuck too deeply into the DC pie to let it all just slip away without fighting tooth and nail. There are too many people who believe the gravy train of benefits coming out of DC should be endless to kiss that goodbye without a fight.
Look at what has been happening in Greece. They’ve built up two generations of people who cannot and will not accept that they’re simply out of money. Despite the fact that system has been thoroughly looted, they are adamant that the looting should continue.
If we don’t cut spending—and I mean real cuts, not cuts to some imaginary baseline that has $9 trillion is spending increases baked in—and some sort of serious tax reform that widens the tax base to raise more revenue, we’re done.
And don’t come back at me with some lame "Our GDP:Debt ratio was 120% at the end of WWII" silliness. Yes it was. And you know how we fixed it? We cut Federal spending from $92 billion in 1945 to $38 billion in 1949. For 2011, 40% of the federal budget was financed with borrowed money: We’ll spend $3.818 trillion, of which $1.645 trillion is borrowed. If we funded only defense, Medicare/Medicaid, and Social Security, and interest on the debt, we’d still have a deficit of $673 billion. Just to balance the budget this year—forget paying off any debt—we’d have to cut an additional ~25% from Health, Defense, and Pensions. Follow the link and download the CSV file, open it up in Excel, and run the numbers yourself. The magic number to balance the budget this year is the revenue of $2.174 trillion.
There’s no big mystery as to why we got a downgrade from S&P. The mystery is why Fitch and Moody’s haven’t downgraded US debt yet.
To begin paying down the debt will require massive cuts in government spending, substantially widening the tax base, and some healthy economic growth—and good luck with that as we add another couple hundred k government workers to the unemployment roles, lay off 1/3 of government contractors to boot, and start asking the bottom 50% of taxpayers to actually, you know, pay taxes, along with everyone else.
If you’re under 50, and reach retirement age with any modicum of personal wealth, you can forget seeing a dime in Social Security or Medicare benefits when you retire. You’ll be means-tested right out of all that.
You think the debt ceiling battle was disruptive? Well, hold on to your hats, folks.
Well, this is encouraging:
U.S. government officials are bracing for the rating agency Standard & Poor’s to downgrade the country’s credit as early as this evening or take other possible action, according to someone familiar with the matter.
Open comment thread to answer the question: How screwed are we?
UPDATE: ABC news adds more:
A government official tells ABC News that the federal government is expecting and preparing for bond rating agency Standard & Poor’s to downgrade the rating of US debt from its current AAA value.
Officials reasons given will be the political confusion surrounding the process of raising the debt ceiling, and lack of confidence that the political system will be able to agree to more deficit reduction. A source says Republicans saying that they refuse to accept any tax increases as part of a larger deal will be part of the reason cited. [Emphasis added—Ed.]
So, it’s all your fault, Republicans.
UPDATE II: Politico’s Ben White (@morningmoneyben) tweets, "Senior govt official tells me S&P had planned to downgrade 2nite. And now may not. Weirder and weirder".
UPDATE III: Jake Tapper updated the ABC story above with new developments:
A third official says that S&P made a "serious mistake" in its analysis, "based on flawed math and assumptions," so the Obama administration is pushing back. But even though "S&P has acknowledged its numbers are wrong, it’s unclear what they’re going to do.," the official said.
S&P refused to comment.
What a strange set of developments.
Update IV: The Wall Street Journal provides a clearer look at what’s happening:
A mathematical error discovered late Friday by Treasury Department officials threw into limbo, at least temporarily, plans by ratings firm Standard & Poor’s to downgrade the top-notch AAA credit rating the U.S. has held for 70 years, people familiar with the matter said…
S&P officials notified the Treasury Department early Friday afternoon it was planning to downgrade the debt, a government official said, and the firm presented its report to the White House. S&P has previously warned such a downgrade might come if Washington didn’t move to comprehensively tackle its long-term fiscal woes.
After two hours of analysis, Treasury officials discovered that S&P officials had miscalculated future deficit projections by close to $2 trillion. It immediately notified the company of the mistakes.
S&P officials later called administration officials back to say they agreed about the mistakes, though they didn’t say whether it would affect the rating. White House officials remained waiting Friday evening to see what the company would do.
That’s an enormous mistake for S&P. If you’re about to issue a downgrade to the United States, you’d better check yourself, son. After this, the Treasury Department will go to the wall on S&P if they try to downgrade.
Big black eye for Standard & Poor.
UPDATE V: Holy crap! CBS White House reporter Mark Knoller (@markknoller) just tweeted: “S&P has downgraded US Treasury securities from AAA to AA+. S&P bills downgrade as an ‘unsolicited rating.’" Oh, it’s on now. S&P has got big brass ones, because the Treasury Department and White House will now go 10-8 on their ass, after finding that $2 trillion math error.
UPDATE VI: Well, the first responses for the downgrade are in at Reuters. They seem pretty measured. Optimistic even.
Well, this is interesting. Paul Krugman finally agrees with me:
[W]e already know what isn’t working: the economic policy of the past two years — and the millions of Americans who should have jobs, but don’t."
I’d just like to point out that I knew those economic policies wouldn’t work back in 2009, writing about them here. Since then, I’ve just been watching the kangaroo. So It’s nice to see Krugman joining me in declaring "fail"—though he does so with the advantage of 20/20 hindsight.
I eagerly anticipate my upcoming invitation to Sweden.
Where we diverge is in providing solutions. As always, Krugman’s solution is more spending, and more debt. But with debt already at 100% of GDP, we’re really in uncharted waters, and I have no confidence that more debt is the answer, if the problem is the existing debt overhang.
The real question I’m concentrating on is, "At what point do the markets recognize not only that the debt path we’re on is unsustainable, but that it is going to be impossible to pay it back?" Is that 120% of GDP? 150%? I don’t know. But I fear that we’re going to learn the answer.
On the bright side, I’ll be able to pay off the remaining 19 years of my mortgage for the cost of a nice hat. On the down side, a new Astros baseball cap will cost $200,000. On the bright side, again, the $100,000 from my Nobel will cover half of that, so it’s all good.
James Pethokoukis writes, "Goldman Sachs drops this H-bomb on the Obama campaign:
We have lowered our forecast for US real GDP growth further and now expect real GDP to grow just 2%-2½% through the end of 2012. Our forecast for annual average GDP growth has fallen to 1.7% in 2011 (from 1.8%) and to 2.1% in 2012 (from 3.0%). Since this pace is slightly below the US economy’s potential, we now expect the unemployment rate to be at 9¼% by the end of 2012, slightly above the current level.
Even our new forecast is subject to meaningful downside risk.
So, we got that goin’ for us.
The headline numbers for the the July employment situation show that 117,000 new non-farm payroll jobs were added last month, while the unemployment rate dropped to 9.1%. But, the true story is—as we’ve come to expect—more complicated when you delve below the fold.
Private payrolls rose by 154,000 jobs, while government payrolls declined by 37,000. Average weekly hours were unchanged at 34.3, while hourly earning rose slightly to $23.13.
The decline in the unemployment rate to 9.1 was not a reflection of the increase in non-farm payrolls, but a decline of 193,000 in the labor force, as workers dropped out of the labor market. As a result, the labor force participation rate continued to decline to 63.9%. In addition, the total number of employed persons declined from 139,334,000 to 139,296,000, meaning that 38,000 fewer people were actually working last month, compared to June.
The U-4 unemployment rate, which includes discouraged workers, held steady at 9.8%, while the broadest measure of unemployment/underemployment, the U-6, which includes workers who have part-time jobs for economic reasons, dropped 0.1% to 16.1%.
Overall, the report is not positive. At best, it can be said that we’re about the same last month as we were in June. The trend over the last few months is not good, however, as the table below illustrates.
|Mar 2011||July 2011|
Finally, if we go back to the historical average of labor force participation prior to the recession, which was 66.2%, the proper size of the labor force should be 158,662,000, rather than 153,228,000. Use that figure to calculate the employment rate with the 139,334,000 persons actually employed, and you get an actual unemployment rate of 12.2% for July. The caveat here, of course, is that with the first tranche of Baby Boomers so close to retirement, some number have just retired early and are out of the labor force permanently, so that historical participation rate may no longer be valid.
In any event, once you add in the workers who’ve gotten discouraged, and workers who have part-time jobs because full-time employment isn’t available, this month’s employment report makes it clear that real unemployment is actually back on the rise.
Let me see if I can quantify the current and future budget situation. It’s actually quite simple, and doesn’t require knowledge of anything other than elementary mathematics. The most recent analysis of the Federal government’s unfunded liabilities, to include the national debt, debt financing, Social Security, and Medicare, showed total unfunded liabilities of $61.6 trillion. I’ve seen substantially higher numbers in other analyses—up to $75 trillion, depending on how you score it—but let’s take this fairly conservative one. What are the practical implications of this number?
Let’s see what we’d have to do to pay all that back in 30 years. I picked that length of time because a) it covers the entire span of Baby Boomer retirements, and b) it equals the longest maturity of any Federal debt instrument, the 30-Year Note.
Let’s look at the rounded numbers, derived from the Statistical Abstract of the United States. In fiscal 2010, GDP was $14.63 trillion. Of that $2.165 trillion was collected in Federal revenue, or 14.8% of GDP. $61.6 trillion, paid over 30 years, will require equal installments of $2.05 trillion every year.
Now we’ll make some assumptions. Let’s assume that we get 2% growth this year, and that for the next 29 years, we get an average of 3% growth in both GDP and in tax revenues collected. We also have to assume that the US Government doesn’t run a deficit, or add and more to the national debt between now and 2041. And let’s even assume that the current 14.8% of GDP we’re currently collecting in revenues doesn’t rise to the the historical 17.8% average, and that we can fund the government on just revenues of 14.8% of GDP.
Finally, let’s remember that most revenue that has ever been collected in all of American history, as a percentage of GDP, was 20.6% in 1999, after a substantial economic boom. Prior to that was 1945’s 20.4%.
In order to pay off this year’s share of the $61.6 trillion in unfunded liabilities, the government will have to collect $4.261 trillion in revenues. With an estimated 2011 GDP of $14.922 trillion, that comes to 28.6% of GDP. If we assume government revenues rise to the historical average, the we’ll need the government to take 31.6% of GDP in tax revenues. Happily, because we’re assuming a 3% rise in GDP and revenues for every year over the next 30 years, that percentage will decline slightly every year, until, in 2041, we’ll only need to collect 20.5% of GDP in tax revenues to pay off the last installment, assuming, again, 14.8% of GDP covers the operation of government. If we go back to the 17.8% figure, then we’ll have to collect 23.5% of GDP in revenues.
Either way, for the next 30 years, we need to collect substantially higher tax revenues than we have collected at any time in the nation’s history, and we have to do it every year for 30 years.
Quite frankly, I doubt that this is even physically possible, much less politically possible. Quite apart from anything else, I have no confidence whatsoever that we will even have 3% GDP growth under a regime where more than one-quarter of national income is given to the government for the next decade.
If you want to see the year-by-year numbers, my Excel worksheet is here.
UPDATE: A commenter points out that http://www.usdebtclock.org/ shows a total unfunded liability of $114 trillion. I believe that figure goes out to the year 2087, however. But, those calculations wouldn’t look that much different for individual years. We’d just have to support unsustainable taxes for 70 years instead of 30. Not that it matters, ‘cause we won’t do it anyway.
BTW, keep in mind that these numbers are just a simple back-of-the-envelope calculation to wrap our heads around the basic scope of the problem, not a precise model of government expenditures and revenues for the next 30 years. I wasn’t really interested in doing 20 hours of math for a 15-paragraph blog post, after all.
I did a little PHP programming this evening.
It’s now 1:00am. I worked for 1.5 hours on the previous post, hit publish…and the only thing that got saved was…the title of the post. All that work gone.
But I’m a stubborn SOB. I spent some time searching for some offline blogging tools, only to discover that I already had Windows Live Writer 2011 installed on my netbook. And it’s great. Not perfect, but at least I now can write and save drafts locally, and I won’t lose an entire post to the vagaries of the online editor in WordPress. And it’s free!
It supports the blog theme, categories, tags, media uploads, and just about everything I use on a regular basis. It’s way better than the clunky blog publishing feature in Microsoft Word, and it doesn’t have all that extra word processing/desktop publishing stuff that Word has. It just has tools specifically relevant to writing and editing blog posts, plus comment moderating and administrative tools. And in addition to the WYSIWYG editor, it has an HTML editor and a preview screen built in. Apparently, there are also a number of plug-ins available for it that I’m now keen to investigate.
I’m not usually a big rah-rah guy for Microsoft software, but this Writer application really works.
I re-wrote the previous post in Writer, saved a local copy of it, then hit Publish, and it all worked as smooth as a baby’s behind. I heartily recommend Writer. it’s a pretty neat little application.
Now, I can go to bed.
And, yes, I wrote this post in Writer, too.
Let’s see how today went, shall we? We got our debt ceiling deal, but the Dow dropped 266 points, and the S&P 500 fell 33 points, so it’s now negative for the year. The yield on the 10-year T-note dropped to 2.61%. Gold, meanwhile, hit a fresh record high of $1,644.50/oz. So, I guess this year’s Recovery Summer is over.
None of this, by the way, has anything to do with the debt limit battle in DC. No one on Wall Street really thought a deal wouldn’t be struck. At the end of the day, everybody was pretty confident that the debt ceiling would be raised, and a default avoided.
Stock prices are volatile, of course, so one day’s movement doesn’t mean much, but we have lost about 800 points on the Dow since 22 July, so the trend isn’t good. What’s worse is the steady decline on treasury yields and the climbing price of gold. When you couple that with the 0.4% 1Q GDP increase, and the danger of downward revisions to the lackluster 2Q GDP over the next two months, the evolving picture doesn’t look pretty. We’ve also has a few weeks of unremittingly bad economic releases, showing the economy might be heading back towards recession, and unemployment getting closer to 10% than 8%.
So then what’s the problem? I mean, we’ve had our big stimulus, and our TARP and our Quantitative Easing I and II, and we’re still not only barely budging into positive GDP territory, but now all the signs are showing the economy slowing. What’s happening? Why isn’t any of this working?
I think the answer can be found in what I wrote in my previous post about debt levels, and how over the last several years…
…a body of peer-reviewed work has been developed (PDF) that shows that an excess of government debt serves as a drag on the economy, shaving at least a full percentage point off of annual GDP growth. And we’ve learned that this negative economic effect has a non-linear effect on economic growth as debt increases.
What seems to happen is that, as you begin to approach a debt-to-GDP ratio of 100%, economic growth slows. As you add debt, there’s a non-linear decrease in economic growth. and each additional increment of debt slows growth more than the last. As I also pointed out, this has some pretty scary implications for Keynesian policies, because as you add debt, you’re no longer stimulating growth, you’re hindering it ever more strongly.
That puts policy makers in a pretty bad spot. For instance, right now, real short-term interest rates are effectively zero, so the interest rate tool is no longer of any use to the Fed. You can’t lower rates below 0%. With that tool gone, the only thing left to try and stimulate the economy is to add more debt. Conversely, cutting spending will result in more government workers and contractors being moved over to the unemployment line, and the economy still slows. It’s a trap, where all the standard policy moves result in a slowing economy.
Back in the 80’s my fellow Econ and Business undergrads would debate about all the debt Reagan was adding, and trying to figure out when all that debt would begin crowding out private investment and slowing economic growth. As it turned out, it took far longer than any of us believed it would, but I think we finally have the answer.
The really scary this is that, if we decided that we had to bite the bullet, and impose some austerity, it really wouldn’t help much. We could cut discretionary spending by half, and all it would do is gain us a few years of breathing space before the coming explosion in Social Security and Medicare entitlements—about $60-76 trillion worth of them—eat up any short-term savings and debt reduction we might acquire. After all, discretionary spending—including defense—is only about 39% of the current budget anyway.
What part does economic growth play in all this? Well, it’s clear that 2% per year isn’t going to help much.
It is a generally accepted truism that the trend rate of growth in a mature economy is 3%. There are a lot of reasons given for this; slower population growth in developed countries, large sunk costs in plant and capital, blah, blah, blah. But why should any of that matter? Just because population growth is slow, it doesn’t necessarily follow that the growth of wealth or human ingenuity is hampered.
Here is a reason for that slow growth that’s almost never given. You see, one of the things that mature economies all seem to have in common is large government expenditures, extensive entitlements, massive regulatory oversight, and increasing debt. All of that is financed by taxation to remove money from the productive portion of the economy. So, one of the primary reasons we have slower economic growth is because we trade it for public goods.
Now, we may love these public goods. And they are certainly nice to have if you can afford them. But the evidence is increasingly that we cannot. if we could, we wouldn’t be racking up a level of peacetime debt that’s nearly 90% of GDP. Not only do we give up a lot of economic growth to sustain these public goods, but, apparently, we eventually give up all of it…at which point, we have to give up the public goods as well.
If we really want to climb out of this hole, then what we really need to do is to radically rethink what government should be, what it should be allowed to do, and how it’s funded. It’s not enough any more to cut budgets, while leaving the regulatory, entitlement, taxation, and spending structure intact. A truly radical solution would be to limit government spending and revenues to no more than 10% of GDP in peacetime. Replace the income tax with a 10% VAT. Eliminate the departments of Education, Commerce, Labor, Transportation and Agriculture. Repeal most Federal criminal laws. Privatize social security. Enforce free markets, rather than the crony capitalism we have now.
No one in our current political class has the slightest interest in any of those suggestions. Drastically reducing the size and scope of government is the only solution that can possibly increase economic growth substantially, and give us a shot at paying off our ever-increasing debt, but our current political class will never embrace that.
The thing is, reality doesn’t care what the political class—or anyone else for that matter—wants. It just is what it is. So, no matter what happens, we won’t have to worry about the deficit or government spending for much longer. Either we’ll fix the problem by electing a political class that’s devoted to cutting government across the board and paying down the debt. Or we won’t fix the problem, and the resulting bankruptcy and hyperinflation will allow us to monetize our debt, wipe out the life savings of every person in the country, and we will start over from scratch with a bright shiny new currency!
But the problem will get solved. The only question is how much control we’ll retain over the process, and how much government we’ll retain at the end of it.