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Without decisive action on the part of Congress and the President or the states, the size of Federal debt in the next 15 years will dig a financial hole deep enough to bury our economy and destroy our National security. 

Polls demonstrate 85% of Americans agree these issues are a overriding concern. But political leadership is in denial of the new Fiscal Realities that will dominate American governance for the foreseeable future.

Why today’s situation is so unique.   The Federal Government’s Fiscal Dynamic has drastically changed and reversed.  From 1946 thru 1980 revenues grew faster than spending, despite tax cuts.   This was true because Congress exercised budget control over more than 80 % of Federal spending in the annual budget review process compared to less than 40% today (and falling).  A vibrant post war economy increased revenue at a healthy rate without tax rate increases and even as tax rates were reduced.

From 1946 though 1980, average revenue growth was 6.1% while spending grew annually 5.9%.  The economy, (e.g. The Gross Domestic Product or GDP) , grew faster than debt levels causing the all important debt as a percentage of the economy or the debt to GDP ratio, to fall from about 120% in 1946 to under 30% in 1980.

From 1980 until 2007, the same favorable spending – revenue trend existed.  A vibrant post war economy increased revenue faster than spending without tax rate increases.  However, this period was different from 1946 – 1980 because, although the same favorable trends existed, tax cuts caused actual revenue to grow slower than spending, increasing absolute debt levels and the critical debt to GDP ratio.   (A graph showing actual debt to GDP ratios for the period is available on request.)

This ratio is crucially important because it is the primary metric investors use to gauge whether a country, and its currency, are safe investments.   There are other considerations such as the size of the economy; the degree debt is funded from domestic savings versus from foreign investors and whether the country is incurring a positive or negative balance of trade. (1)  Exploring the interdependence between these variables, is beyond the scope of this paper to explore in depth.  But its clear America is today headed in the wrong direction when measured by all these variables.  Since WWII we have witnessed deterioration from having a positive balance of trade to and running chronic deficits.    We’ve morphed from being a net creditor to a net debtor nation, our savings rates have eroded and especially since the year 2000 we’ve incurred unprecedentedly large and increasing budget deficits and levels of external debt.

 The ‘tax cuts will close deficits’ illusion.   From 1980 through the early 1990s, the American economy was managed under the illusion that ‘tax cuts would encourage faster economic growth and therefore the deficits thus created by these tax cuts would be closed without practicing spending control.  But the closure of deficits never actually occurred.    What did happen was the favorable underlying revenue – spending trends made it possible for the government after cutting taxes to forecast revenue growth exceeding forecast spending and for the deficits created by those tax cuts to close.    In fact, these positive forecasts never materialized until the late 1990s when budget surpluses were finally achieved in 1998 to 2000 because spending control was exercised.   So the favorable underlying revenue spending trends allowed this illusion to persist and govern America’s economic governance despite the continued disappointing results.

But in 2010 the retirement of the baby boomers reversed this favorable revenue  – spending trends.   In 2008, the worst recession since the 1930s, temporarily masked these changes but the ‘tipping point’ occurred as illustrated graphically below.   From 2016 on, expanding deficits are projected with revenue falling behind ‘automatic’, formula driven, entitlement spending growth.  Even under the most optimistic assumptions regarding economic growth.  Our national political leaders have not been able to agree on policies adequate to deal with these new fiscal realities and the result is continued growth in both absolute debt levels and the debt to GDP ratio.  Pew Trust and other polls show over 85% of the American People understand this fiscal trajectory is unsustainable and the immorality of passing to our children the cost of their parent’s prosperity and  jeopardizing our children’s economic and job creation possibilities.   But this is precisely what we are doing.   And unless arrested, these new realities will create a nightmare out of the American Dream, for us, our children and grandchildren.  Recent forecasts reinforce this new unpleasant reality.What follows is a summary and sensitivity analysis of  latest Congressional Budget Office (CBO) forecasts.

(2) Current Congressional Budget Office (CBO) projections illustrate the economic threat. They also present a political opportunity to one of the major parties, or even a third party as occurred in Britain, that  can capitalize on it.  To found a movement by articulating effectively the reality that the current fiscal trajectory is jeopardizing all our economic futures and the survival of existing welfare and entitlements programs as well as America’s international leadership.   There is a unique opportunity to the pasty or coalition of parties capable of defining the policies needed to arrest this trajectory that 85% of Americans know has to be changed.     There lies here the basis for a new political  message and  movement.

The threat summarized.  Between 2009 and 2012, the federal government recorded its largest budget deficit relative to the size of the economy since 1946. As a result, total debt held by the public is today equivalent to 74% of the economy’s annual output or gross domestic product (GDP).   The current debt to GDP ratio is almost twice its historical average.  It is higher than at any point in US history except briefly at the end of World War II.  It is twice the percentage that it was at the end of 2008.

If current laws remain generally unchanged, deficits and the debt to GDP ratio will decline slightly through 2016 but then grow continually even under the most optimistic economic growth scenarios.   In 20 years or less, it will approach 100%, under ‘current law’.   The CBO report states this growth cannot be sustained and a growing body of economic analysis demonstrates that at debt to GDP ratios exceeding 80%, economic and job growth both suffer.  The CBO acknowledges this reality but does not factor it into their forecast.

The official CBO forecasts are in other ways unrealistically optimistic. This is true because the forecasts are based on ‘current law’ which counts on certain tax cuts expiring and automatic spending cuts being implemented.    If future Congresses changes these laws to increase spending and reduce revenue as past Congresses have done in the past, the debt to GDP ratio will exceed 180% as summarized below.  When Europe experienced its recent crises, this ratio for Greece and the other weaker counties like Italy and  Spain was between 100 and 120%.   We are vulnerable. (2)

                          Current         Historic              2024              2034 

Debt/GDP*           74%               40%               80 – 100%      100 – 180%

Deficit /GDP        4.5%              2.5%                 3.0%            4.5%

Interest/GDP      2.5%              2.0%                 3.5%            4.5%

Footnote to table:   Does not include “Trust Fund” intergovernmental debt such as the Social Security system and  military and civilian retirement “trust” funds which add to external debt when pay outs occur but not before.   Only external debt is included because this is what CBO forecasts.  Abrogating external debt is impossible and unthinkable   Abrogating Trust fund debt would be extremely disruptive.   Over 50% of Americans over 65 rely primarily on Social Security and if military and civilians pensions were cut, the reaction would be severe.  If Trust Fund debt is added, these ratios will be increased to 102% in the current year and roughly proportionally thereafter.

 

Growth in the debt to GDP ratio is propelled primarily by the reality that 25% of the American population, called the post WW II Baby Boomers, started to turn 65 in 2010.  Also by the associated growth in per capita health care costs, Social Security and interest on existing debt that will double compared to the past 40 years.   Today interest on  the debt equals to the entire Defense Budget.  By contrast, spending for programs called discretionary programs that fund the classic government services, including defense, will  decline to about 11 % of total government spending from today’s  level of 40% and historical levels of about 80% that applied immediately after WWII.

3) What happens if we do nothing?  The country will become increasingly vulnerable to credit crises, deeper recessions and even depression. High debt to GDP ratios will negatively impact future economic growth rates leading to higher debt to GDP ratios and slower growth.  An example of the sudden and seismic loss of credit market confidence is the disruption to the short term ‘commercial paper’ credit markets which in 2008 drove many old and trusted investment banks into insolvency and bankruptcy.

For examples of counties experiencing credit crises, one needs look no further than the recent European Union crises.   Economic growth not only stopped.  For these counters GDP contracted along with employment.  For some counties by over 25% .  It’s taken over seven years  for the Greek economy to at last return to positive levels of economic growth and government programs cut and promises broken.    Credit and currency markets are emotional and ruthless once confidence is shaken and currency wars are real as has been well documented. (See “Currency Wars” by James Richards).

The interest rate illusion and associated interest trap.  Interest rates are lower today than at anytime since WWII masking the potential adverse impact of rising debt on the Federal Budget.  From 1980 through 2006 debt grew from about $1.0T to over $15.0T while the cost of federal borrowing rose less than 20%. If rates were to return to 2006 levels, federal spending would increase by over 25% or $750.0 Billion with nothing of real value purchased by these funds.   This spiraling ‘interest debt trap’ is typical of countries in crises and America is not immune.   We’ve already discussed the Greek experience.

The potential for an adverse feedback on growth and job creation is being aptly called an ‘economic doom loop’.  Large federal borrowing draws savings away from private investment and other productive uses of capital.  People’s savings are used to buy government securities and that are not therefore available to finance productive investment.  Slower economic growth and job creation and will restrict the ability of people to move up from one social level to another and the income and wealth gap would widen. The seeds are sown for social unrest on a large scale. Yes, the American Dream could easily become a nightmare.

The CBO forecast also warns that the large amount of debt will “restrict future government’s ability to use tax and spending policies to respond to crisis like the financial crises of 2008”.  This is an understatement.

(4) Implications for America’s National Security?  Two Chairmen of the Joints Chiefs of Staff, Admiral Mike Mullen and General Martin Dempsey have called the national debt and budget trends, the greatest threat to America’s national security.   Both are concerned about the crowding out of national security funding and the threat of creditor blackmail in crises similar to America’s actions with the British in the Suez crises of 1957.(3) 

(5) Why a Balanced Budget Amendment is needed. The political dialogue since 2008, particularly over the debt limit, resulted in Congress resorting to sequestration to achieve spending control.  This demonstrates again that Congress is simply incapable of limiting spending without an outside control mechanism like sequestration or a BBA.  Congress needs a forcing mechanism to help Congress control spending.  The national political process has increasingly demonstrated the failure of the governance process to control spending.  Two examples are the failed Graham Rudman efforts from the 1980s and the later failed Pay Go efforts  And since 2010, Congress’ inability to achieve the ‘Grand  Bargain’  needed to close the deficit gap beyond three years and deal with the resulting the uncertainly that’s dampening the current economic recovery, is another example.   The BBA would allow flexibility in crises but also give politicians the backbone they need to implement allow the needed spending control they know they must implement.

Update on progress with the BBA article v process available upon request at JohnKnubel@gmail.com

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