Has “the debt crisis” gone the way of the domestic ebola scare? Here today gone tomorrow? Or is it a ticking time bomb, as some hyper vigilant purveyors of the dismal science still warn? With stronger economic growth, low interest rates, and six consecutive years of diminishing deficits, the (accumulated) federal debt problem seems less acute or urgent. But, it would be foolish to say it’s gone away, or that “it doesn’t matter,” as Dick Cheney proclaimed in 2002, before the debt approached World War II proportions as a percent of the economy (or GDP).
Economists use the Gross Domestic Product [GDP] as the denominator in computing the key “ratio of debt to the size of the economy.” That ratio is a lot more informative than the absolute size of the debt.
The debt ratio has stabilized at about 100% of GDP, after soaring from 54% to 95% between 2001 and 2011, or more than $6 trillion. The long history can be seen here. Most of this explosion was due to financing two wars and a buildup of homeland security, while allowing generous tax cuts to upper income Americans. On top of that was the TARP bail out of financial institutions and plummeting revenue resulting from the Great Recession. The later actually dwarfs the other factors. Public debt didn’t cause the Great Recession; it was the other way around.
All of this was set in motion, and well underway, before President Obama took office in 2008. The President’s contribution to the deficit was an $800 billion “stimulus” package, a second TARP, and refusing to brake hard on federal spending, which would have sunk the economy into even deeper recession.
The most important fact in this essay is that the debt ratio has stabilized at around 100% of GDP. Except for WWII, that is the highest ratio since the inception of the Republic (1787).
Debt at 100% of GDP means the total amount owed by the U.S. to holders of U.S. Treasury securities, is roughly equal to the value of all goods and services produced in the U.S. economy in a year, like 2014. That’s not good, but it’s not as horrible as it sounds either. Analogies to family budgets here can be misleading, but it is useful to point out that if you own a $300K home and still owe $100K on it, and your annual household income is $100K, not an atypical scenario, you are not in deep trouble. (Though you may be one bad life event away from real tsouris).
The critical GDP to debt ratio reached 120% of GDP at the end of WWII, but phenomenal post-war economic growth brought it down in just 15 years to 50% of the total economy, about where it had been before WWII. It has since remained in the 30% to 60% range until the 2008 Great Recession.
This time, however, conditions after the latest Hurricane Katrina Category III economic stress are different. The economic recovery from two costly wars and a great recession has been slow, till recently, when it surged into the 4 to 5 percent range in the last half of 2014.
But nobody thinks U.S. GDP will grow at that rate for the next decade or two, which is what it would take to duplicate the post WWII feat (dropping the debt ratio from 120% to 50%).
In fact, most purveyors of the dismal science think the ratio will rise above the current 100% plateau after about 2018, even without another economic downturn. Why? The non partisan Congressional Budget Office (CBO) says its because of four factors:
• The retirement of the baby-boom generation,
• The expansion of federal subsidies for health insurance,
• Increasing health care costs per beneficiary, and
• Rising interest rates on federal debt.
We may not need to worry about bullet point #2 when the U.S. Supreme Court strikes down federal subsidies for health insurance later this year, but that’s a digression. CBO bullet point #4 is the most pertinent to the question at hand.
If debt at 100% of GDP is the new normal, there is little room for anything to go wrong without really upsetting the applecart. That’s the main reason I’m not quite as sanguine about the debt as astute economists like Jared Bernstein (see a great article by him here) and Paul Krugman, who sound very close to saying “fogettaboutit” (the debt) for awhile. OK, but how long is “awhile?”
Just like CBO bullet point #4 says, as the Federal Reserve recedes from its easy money policy, interest rates will rise on the debt. What this means is that interest payments on the debt will crowd out other spending. The U.S. isn’t Greece, Italy or even Japan, but those basket-cases show what happens when debt service is so large that it materially affects core government services. It makes any ambitious reforms, like the President’s proposals in his state of the union speech to revive the middle class, all but impossible.
Interest payments on the debt have also stabilized at “only” about 6% of federal outlays, but that’s mainly because interest rates have been so (artificially) low – at rock bottom — for so long. As recently as the year 2000, interest payments on the debt were 15% of total federal outlays. The U.S. is unfortunately more than capable of getting there again, quick.
How big is 15% of the federal budget? Fifteen percent is more than what’s spent on all safety net programs other than medicare, medicaid, and social security. Unbelievably, it’s not much less than the 19% devoted to national defense.
If you can still remain blasé about the 100% debt to GDP ratio after hearing that, please tell me what you’re smoking. (Cannabis is still illegal in California).
That said, it is utter folly to try fixing the problem overnight, the way radicals in the House Republican caucus and far right demagogues in the blogosphere would still prefer. Getting a handle on the problem without the severe pains of a German imposed Greco-Roman austerity (now, there’s a trifecta) is still well within our reach. But that’s possible only with a Grand Bargain that includes both a slow down in spending and new revenue, and which takes at least a few baby steps, sooner than later.
Alas, even toddler steps will require serious regime changes (across all branches in D.C.) and major attitude adjustments. The longer that takes, the harder it gets to find even a long term solution that doesn’t inflict great pain.