America seems to have a lot of problems: health care, unemployment, education, homelessness, poverty, the list goes on and on. We talk about many of these problems, and sometimes somebody even tries to solve one of them. We call these people idiots.
But there is a much larger problem we refuse to acknowledge, and it is the one that will destroy us in the end. It’s called debt, and if we’ve learned nothing as individuals from this recent economic turmoil, it’s that debt can really mess you up.
The United States is extremely deep in debt—the federal debt, the sum total of money we owe to creditors (in the form of Treasury notes and bills, and Treasury bonds), was over $12 trillion, an amount the human mind is not capable of comprehending. It is roughly 85% of our total gross domestic product.
Of this debt, roughly 3/5 is held by the public, in the form of notes and bills and treasury bonds, but mostly notes and bills. Of this, about 55% is held by American citizens and corporations, while the remaining 45% is held by foreign investors (2/3 by foreign governments, particularly Japan and China, the rest by foreign companies and individuals). China’s central bank holds about $900 billion of U.S. debt—about 8% of the total.
The remain 2/5 of the debt is held by agencies within the government itself. The Social Security Administration, for example, has thus far spent its annual surplus (there are still more workers paying in than recipients, though that will reverse in the next five years) on buying government debt; it will then collect on that debt as it matures to continue paying recipients. This, of course, will force the government to sell more debt securities, since Social Security will no longer have a surplus and will not be buying new securities to replace those it collects on; finding investors for this new debt is not guaranteed.
In 1950, at the end of World War II, the national debt stood at 94% of GDP (then a much smaller figure). By 1980, it was 33% of GDP, although in gross terms it was quite a lot larger (still under a trillion dollars, though). By 1990, after a decade of that great conservative government-shrinker Ronald Reagan’s influence, the debt had risen to 56% of GDP and $3.2 trillion. In 2000, after (most of) a decade of prosperity and high tax receipts, it stood at 58% of GDP, $5.6 trillion. At the end of 2008 as our great Republican leader was leaving office it stood at 70.2% of GDP and over $10 trillion. The records of Reagan and Bush are clear, and this is why when Republicans say they care reducing the debt, I know they are full of shit. The same tends to be true of Democrats, and certainly the debt has increased substantially since the change of administrations—though that being said, government spending is appropriate and desirable during economic downturns. The problem is that we justify our spending to stimulate the economy when it’s weak (“prime the pump” was the phrase during the Depression), then fail to cut back when the economy is strong. So the debt continues to grow. Congressional Budget Office estimates indicate that by 2012 the total federal debt will exceed GDP.
This should concern you. Not because China might come to us tomorrow and demand all their money back—-treasury securities are time-delimited—-but because once we as a government owe more than we as a people produce in a year, our debt begins to look risky to investors. Investors may begin to demand higher interest rates on our sovereign debt, and higher interest rates means our total interest payment goes up, and we have to sell more debt.
There is no reason to assume American sovereign debt is inviolable, although that tends to be the assumption worldwide. Partly, however, this is because America has always been seen as a responsible debtor, able and willing to pay its debts on time without devaluing the currency or inflating the debt away as other countries are prone to do. Before the inception of the Euro, Italy had a habit of devaluing the lira every decade or so; this meant that an investor who spent $50,000 on a 100,000 lira bond would, after devaluation, get back 100,000 lira that were worth only $5,000. Back in the days when most currencies were on a gold standard, devaluations occurred against the price of gold, but with the same effect. The United States, however, didn’t resort to such trickery, partly because we always had enough wealth in the country to find buyers for all of our public debt. When the international financial system was set up, the dollar was accepted as a standard of value because the U.S. government had a long history of maintaining that value. We were the good guys, the responsible managers of money, and as a result our money became the standard of value worldwide. The dollar is still far and away the world’s primary reserve currency, and although that status seems less certain than it once was, an obvious successor is not yet on the horizon.
But now we’re not being responsible any more. We just run larger and larger deficits, and not since 2000 has any administration even discussed the issue of spending less and returning to responsible monetary practices. We still aren’t printing money to try to cover our debts (that would result in hyperinflation, most recently seen in Zimbabwe but best known for bringing interwar Germany to its knees and leading to the rise of the Nazis), and the chance of a sovereign default seems remote (right now, but that can change with remarkable quickness; witness Greece), but financially we are on rather thin ice.
By 2030 (approximately), it is likely that total payouts on Medicare, Medicaid, and Social Security will exceed total tax revenues for entire country. That means absolutely everything else the government does, from national defense to keep toilet paper in bathrooms at national parks, will have to be financed by debt. And beyond 2030 things simply continue to get worse.
The problem comes not from the debt itself, but from the need to finance it. Debt rotates—every so many years, an individual debt security like a treasury bill reaches maturity. The holder can then ask for the money from the government, or roll it over into another treasury instrument. When debt rolls over, it is on new terms. Presently most of our debt is at very low interest rates, but creditors may begin to fret that the risk of a sovereign default is actually real, and thus ask for a higher interest rate to cover that potential loss. Higher interest rates mean higher debt service payments, and higher payments means we have to sell more debt.
As entitlement spending increases, the total quantity of debt we will have to sell will increase, so our interest payments will rise on their own. It only takes a handful of creditors to begin worrying about the possibility of default for interest rates to start rising to unsustainable levels.
This is exactly what has just happened in Greece. Creditors began to worry that Greece, which showed no intention of bringing its spending under control, was going to become unable to make its debt payments. Thus they started asking for higher and higher interest rates. The Greek government had to sell debt at unsustainably high interest rates, and the situation snowballed.
America is not Greece. But America in 2010 is also not America in 1950, and it will take very little nervousness on the part of creditors to start a Greek-style collapse.
Outside the Euro, Greece could have responded to the crisis by devaluing the currency or defaulting on its sovereign debt, things it cannot do within the Euro. The United States has no such restrictions.
Russia defaulted in 1998—-essentially declared bankruptcy and said they wouldn’t pay the debt they owed. Russia’s government then had to sell its debt at junk grade, mostly to Russian citizens (especially the oligarchs), and severely cut services, until the Russian economy began to grow. Through the 2000s Russia’s debt grade gradually improved as the Russian government began running a surplus, and appeared likely to be able to pay off future debts. (In the last year Russian debt has been downgraded again as the economy shrank, but it is still considered investment grade, though just barely.) Russia still pays a lot of interest on its sovereign debt, though; a BBB rating will do that. You pay higher credit card and mortgage rates if you have a history of bankruptcy or missed payments; countries are the same way.
If America found itself unable to sell enough to finance its government obligations-—something that is certain to happen by 2030 if projections hold and nothing is changed—-we would likely default rather than devalue the dollar, because it would cause less global shock (though both options are decidedly unattractive). But unlike Russia, we would not start running a surplus in the next couple of years. Instead we would have to make do with much less government spending, and much higher interest rates. Inflation would no doubt rise, affecting the average American’s pocketbook (including most especially those on Social Security). And certainly, American prestige in the world would never recover.
There’s no reason why it will take until 2030 for this to happen. Entitlement spending may exceed tax revenue by that year, but creditors are unlikely to let the country go that long without taking some form of action against ballooning deficits.
I for one prefer not contemplate a post-default America or a devalued dollar, and I doubt seriously anyone else does, either. But the debt remains a concern only for those outside the government—-the tea party, the minority party, anyone looking to score political points against those in power. But once in power, things change; American politicians, like Americans, are addicted to spending money they don’t have. This will change, and it will do so in my lifetime. But will it be gradual and in a way of our own choosing, or will it be catastrophic? It’s up to us, but so far, we don’t seem interested in talking about it.