Wednesday, December 16, 2009

U.S. Debt Bomb Ticking Away

According to Morgan Stanley, total U.S. credit market debt as a percentage of GDP is higher now than at the peak of the Great Depression.

Now, as then, the government and financial sector are attempting to stave off the economic contraction through debt-financed spending.

But, at present, the collateral supporting much of our public and private debt is worth less than the debt it is supposed to be supporting.

The U.S. is by far the world's biggest debtor nation. US private sector debt is now 350 percent of GDP.

Currently, there is about $3.75 in debt for every $1 in national income. Yet, the national economy can normally support around $1.50 in debt for every dollar of income.

The fact that U.S. and global debt levels are higher now than during in the 1930s leads to the conclusion that the current deleveraging will likely be a staggering economic event.

The dollar has declined 40 percent in value in the last seven years.

Meanwhile, the national debt is soaring and the monetary base has increased by 142 percent over the past two years.

Yet, government spending continues, unabated. Our national debt now exceeds $12 trillion. Military and war spending are a significant aspect of our excess.

In real dollars, defense spending in both the Korean war and the Vietnam conflict, was not as high as it is today. According to Lawrence Korb, the former assistant secretary of defense in the Reagan administration, the indirect costs of our two current wars — veterans benefits, long-term care of the physically and mentally wounded, and interest on the national debt — could bring their total cost to $5 trillion.

President Obama's latest Afghanistan troop increase will bring total forces to nearly 100,000 — at a cost of $100 billion a year. That's nearly $1 million per soldier.

The U.S. dedicates more money to military spending each year than the rest of the world combined. That kind of spending has unintended consequences.

This week, the House will vote to raise the U.S. debt limit by as much as $1.9 trillion. This will raise the cap on government borrowing to about $14 trillion, or equal the size of our nation's GDP.

It will be the ninth hike since 2002, and the fourth in just 18 months. The government has raised the debt limit more than 90 times since 1940.

Such an increase would be more than twice the size of each of the past three debt limit increases. The move will allow lawmakers to avoid having to raise the limit again before next year’s midterm elections.

A surging budget deficit has pushed US government debt to nearly 98 percent of the gross domestic product. If the U.S. was forced to conduct its finances like a corporation, it would be nearly insolvent.

About 46 percent of America’s debt is held overseas by countries such as China and Japan. Interest payments on those debts consume about a tenth of the United States budget.

Remarkably, that percentage is actually down from recent years as interest rates have dropped. When rates eventually go back up, as they inevitably will, the interest payments will rise in response.

Debt payments are already larger than the budgets for NASA ($19 Billion), the Department of Energy ($25.5 billion), the Department of Education ($53 Billion), and Department of Transportation ($73 Billion).

To fund this overspending (aka federal budget deficits), the U.S. Treasury makes and sells a fresh batch of IOUs every quarter. It then uses the cash from these sales to pay off old Treasury debt that has come due, while also maintaining the interest payments on the rest of the paper that is still outstanding.

The government cannot raise enough revenue through taxation to satiate its unwavering desire for rampant spending. The public wouldn't tolerate it and would vote incumbents out of office. So, the Fed prints money (backed by nothing) and then buys Treasuries to finance our government's relentless deficit spending.

And even if the government tried to raise taxes (largely on the highest income earners), it might forestall any potential recovery.

These record deficits have arrived just as the long-feared explosion in spending on Medicare and Social Security begins. As a result, the hole we're in will just keep getting deeper.

The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead.

The Treasury Department’s private-sector advisory committee on debt management has warned of the risks ahead.

“Inflation, higher interest rate and rollover risk should be the primary concerns,” declared the Treasury Borrowing Advisory Committee in November.

In essence, we've been warned.

"Right now, this year, we have 1.6 trillion in debt coming due. That's roughly twice individual income-tax revenue. Our only plausible strategy for paying that back is to borrow more money." – Leonard Burman, an economist at Syracuse University

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