The Advancing Glacier of U.S. Debt

Last Updated Nov 26, 2009 2:15 PM EST

UPDATE: If you're interested in the implications of growing debt, you might want to read a November 26 post on the market's assessment of the creditworthiness of developed-country governments.

Original post, Aug 28:
Along with yesterday's forecasts of slower near-term economic growth, the White House and Congressional Budget Office pointed to larger deficits further out, and a burden of government debt of epic proportions, World War II style. According to the markets, though, the problem may be too far away to start worrying about, as interest rates on long-term Treasury bonds continue to fall.

From the CBO summary report:
CBO estimates that, as the economy recovers, if current laws and policies remained in place, the deficit would shrink but remain above $500 billion per year, or more than 3 percent of GDP, throughout the 2010-2019 period. As a result, debt held by the public would continue to grow as a percentage of GDP during that time. That debt, which was as low as 33 percent of GDP in 2001, would reach an estimated 54 percent of GDP this year and grow to 68 percent of GDP by 2019.
We know the reason for the big deficit this year and next - it's the battle to keep the economy and financial system afloat. This year will see additional spending of about $700 billion, including $133 billion for the TARP, $291 billion to bail out Fannie Mae and Freddie Mac, and $115 billion for the American Revovery and Reinvestment Act. TARP spending is actually $200 billion lower than originally projected, which leads the CBO to estimate the deficit at $80 billion less than early estimates. (I guess they had no trouble finding somewhere else to spend the $120 billion difference.)

But what's creating the enormous deficits further out? CBO assumes growth in real GDP of 2.8 percent in 2010, 3.8 percent in 2011, and average annual growth of 4.5 percent in 2012 and 2013. Full employment is not expected for several years, so there are additional unemployment insurance costs to bear, as well as the tail end of the stimulus. Nevertheless, deficits are projected at 3.1 percent to 3.4 percent of GDP Between 2013 and 2019, well above the 2.4 percent of GDP average over the past 40 years.

CBO explains:
Total spending is projected to head up again beginning in 2013, with outlays for Medicare, Medicaid, and Social Security contributing significantly to that growth. Over the 2010-2019 period, under the assumptions for CBO's baseline, total outlays would average 23.4 percent of GDP-higher than the 20.7 percent of GDP that federal spending has averaged over the past 40 years.

That is, the chronic deficits will be created by programs that are already in place, rather than anything new. In the graph above, the deficit is represented by the gap between the light and dark blue lines. Note that the lines are not converging towards a balanced budget, even as far out as 2019.

This brings us to the debt glacier, where layers are added and frozen in place each year, and removed only with great difficulty. (I realize that due to global warming, few glaciers anywhere are actually growing, but I'm sure you see the image.) Today the public owns U.S. government debt equal to 54 percent of GDP, worth $7.6 trillion. That includes foreign holdings as well, such as those in China and Japan.

At the end of 2010, that ratio of debt jumps to 61 percent, then jumps again and holds at 65 to 66 percent through 2014. And with persistent three percent deficits, the math says it can only go higher.

What's surprising to me is that the bond markets aren't reacting to this news. (I believe rates are headed up, and have expressed that point of view through purchasing an inverse Treasury bond ETF, but so far I am underwater.) Notwithstanding these deficit forecasts for the future, and massive Treasury bond sales to fund today's shortfall, long-term rates are no higher than they were before the financial crisis. I guess the current low inflation, plus plenty of eager buyers outside the U.S. for today's auctions, outweighs the dark cloud on the horizon.

  • John Keefe

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