Tuesday, April 22, 2008

How Does the Elephant in the Room Like Your Lapel Pin?

Charles Gibson, ABC News

Sometimes a problem is so big that everyone is afraid to discuss it. The aggregate liability of the U.S. government, the National Debt, has reached such staggering proportion that officials only discuss it in its parts, lest voters recognizing its massive scale should panic and alarm the beast. That notwithstanding, this elephant in the room is consuming a lot of hay and throwing off a stench that has been noticed by the foreign governments and other investors that have helped finance its upkeep.

According to the U.S. Treasury Department, the total Public Debt Outstanding of the U.S. federal government is $9.4 trillion, of which $5.3 trillion is Debt Held by the Public and $4.1 trillion is Intragovernmental Holdings. The total represents 65% of the $14.4 trillion U.S. Gross Domestic Product, which is the primary measure of total U.S. economic output. It continues to grow whenever total government spending plus interest on the debt (now at rates of 4.5%) exceeds receipts from taxes and government fees, i.e., when the budget is in deficit.

Debt Held by the Public is composed of interest-bearing instruments issued by the U.S. Treasury, mostly in the form of Treasury bills, notes and bonds. When most policy-makers were in school, the debt was excused by Keynesian economists as a cost of full employment. Believing that in a "closed economy" like the U.S. of the early 1970's (i.e., where imports and exports were relatively low) deficit spending would act as an effective stimulus, economists reasoned that the debt was financing a level of prosperity that Americans would not otherwise enjoy. They went on to say that the debt was actually money that the government owed to Americans, since most of it was held by U.S. citizens either directly or indirectly through their ownership of U.S. Treasury securities.

Since then, however, a number of factors have come into play that call this happy model into question.

  • The Congress set up trust funds for Social Security, Medicare, Military Retirement, and Civil Service Retirement and Disability, but then gave itself permission to borrow against these trusts. These borrowings already make up most of the $4.1 trillion mysteriously described as "intergovernmental borrowing." While the public generally believes it is contributing to public savings accounts from which they can collectively draw when they retire, the federal government is actually using the current surplus from those accounts to pay for current operations of other government functions and issuing paper notes back to those funds that amount to unfunded liabilities. The "surpluses" of the latter Clinton years were entirely composed of surpluses in the trust funds; the operating budget of the U.S. government was actually in deficit throughout the 1990's. These operating deficits ended in 2000 but then increased sharply as a result of the 2001 tax reductions, the weakness of the economy following the burst of the internet bubble in 2000 and the increased spending on military actions and civilian security following the attacks of September 11, 2001.
  • A large and growing portion of U.S. public debt, some $2.4 trillion, is held by foreign governments and non-U.S. citizens, including China and Hong Kong ($644 billion), Japan ($587 billion), the United Kingdom ($181 billion), Brazil ($147 billion) and a collection of Oil Exporting countries ($146 billion).
  • The U.S. has become an open economy, enjoying the benefits of free trade, but also subject to its discipline. Economic stimulus measures like tax rebates "leak" from the U.S. economy when consumers use them to purchase imports or invest in foreign stocks. Expansionary monetary measures, such as interest rate reductions, devalue the dollar relative to other currencies, mitigating the intended effects. Hence, the presumed virtues of deficit spending are often exaggerated.
The U.S. has become so indebted to its economic rivals that it is reasonable to question how independently it can exercise foreign economic policy, particularly in its dealings with OPEC and China.

Moreover, the surplus cash being withdrawn from the trust funds will need to be replaced with cash from general tax revenues when these funds go into deficit, beginning around 2018. By failing to invest these surpluses, for example by purchasing back Treasury instruments from the public or foreign governments, the Congress and the Administration have put an untenable obligation on future generations. According to the innocuously entitled 84-page report, "Federal Debt: Answers to Frequently Asked Questions--An Update," issued by the respected Government Accountability Office (GAO) in August, 2004 (GAO-04-485SP) and signed by the Comptroller General of the United States, David M. Walker:
Long-term simulations by GAO, CBO [Congressional Budget Office], and the Office of Management and Budget show that absent policy changes, debt held by the public would rise to levels ultimately unsustainable by the U.S. economy (p.1).

Previously, debt held by the public peaked at about 109 percent of GDP in 1946 following the Great Depression and World War II. ... Due primarily to known demographic trends and rising health care costs, our long-range budget simulations show debt held by the public far surpassing this level in the coming decades (p.40).
If U.S. citizens do not "feel" the impact of current deficit spending, as many commentators suggest, it is perhaps because the public does not understand that the government is spending their retirement funds. Among the measures that could avert this impending crisis are:
  • Reducing federal spending
  • Raising taxes
  • Postponing and/or reducing retirement benefits
  • Reducing Medicare benefits
  • Reducing the rate of increase of federally funded medical costs or reimbursements
  • Increasing the expected number of active workers participating in Social Security and Medicare funding between 2010 and 2040 (such as by recognizing more legal immigrants)
The gross economic imbalances that have arisen in the past decade will need to be addressed by an informed electorate and a responsible administration. And yet, the moderators of a recent Democratic debate thought it would be a good idea to ask the candidates about their positions on lapel pins.

See Federal Debt: Answers to Frequently Asked Questions, by the US. General Accountability Office, a non-partisan agency of the U.S. Congress, for an in-depth discussion of U.S. government accounting terminology and a historical perspective through 2003.

See Keys to the Lockbox, a video by Paul Salmon of Online NewsHour of PBS, for an explanation of the Social Security Trust Fund and to see the actual file cabinet that holds the notes issued to it by the Treasury to fund current operations. The video was broadcast August 22, 2001, three weeks prior to 9/11, when Social Security was the key topic of political debate.

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