Will the US budget deficit cause a financial apocalypse?

I just finished Krugman’s collection of NYT columns, and it brought back up something I hadn’t thought about it a while: how will the deficit be resolved? “Cutting waste” isn’t going to fix it; basically, either taxes have to be raised to levels somewhat above 1999’s, or the combination of social security & medicare have to be cut very significantly.

A more interesting question: what will it take to trigger this? Because one thing and one thing only happens to countries that run enormous budget & capital account deficits for years on end: crushing, bone-grinding, depression-inducing currency panics, with out-of-control inflation.

Edit: To clarify a bit, I’m not talking about the next few years. I’m talking about the completely insane deficits we’ll have in 2020 or so, when the boomers retire en masse. For example, the ratio of debt to GDP - the equivalent of your personal debt to income ratio - goes from 38% today to 50% or so in 2014, then goes crazy.

Argentina’s currency problem really couldn’t happen here. Not saying that we won’t have problems, but a significant element of their demise was that they didn’t want to float their currency so they had the currency board.

There is no way $7 trillion+ of federal debt is ever going to be repaid; you’d have to tax individuals and businesses at enormous rates get it done in less than 20 years and that just isn’t going to happen.

Historically, governments have used two main methods to get out of holes like this: debase the currency and pay off the debt with the resulting fiat money or simply repudiate the debt. Either one means hard times for the country for a long, long time.

I’m no expert, but I suspect our only real solution is to repudiate the debt or tell the banks that they’ll get their principle back and that is it. Since Congress has zero guts, all we can count on is a slow, inexorable slide into Third World status as the interest on the debt grows and eats away any chance of freeing up the money supply for other uses.

Yeah, it depresses me, too.

I’d forgotten about the currency board; you’re right. But all those Asian tigers that melted down in the 1990s didn’t have currency boards.

There’s no reason to repay the whole thing; as long as the debt/GDP ratio stays roughly constant it’s no big deal.

Edit: and the reason it’s a giant problem if we don’t fix it, instead of just a problem, is that we owe foreigners an amazing amount of money.

What we have to remember is that deficits don’t necessarily bring financial destruction. In some times deficits can be a good thing, especially if they are used for infrastructure development, basic research etc.

I like to think of the US deficit in the same way as I think about my household debts. No one likes to rack up big debts but occasionally you have to, when you buy a house, get married, or are unemployed etc. However you hedge the debts to risk that you will be gainfully employed and in an OK situation to pay off the debts. Usually you get to the point where you say to yourseld “holy shit” how much have I spent, and you cut back.

One thing to remember is that even though the deficit is a record level in dollar amounts. It’s still even with the deficits we saw in the 80’s under Reagan, and it’s much smaller than the deficits the US had at the end of WW II and the depression.

One can point out that the deficits at the end of WW II were caused by the war, and the earlier WPA projects, but in the end the debt was constructive, we won the war, we had enormous benefits from the WPA projects, generating plants, road improvements, mathematical tables etc.

What got the US out of any hot water from the earlier deficits were the huge economic booms that occured after the deficits were generated, and the revenue that was generated by the booms. Income taxes on the very wealthy in the 1950’s were huge, and that brought in lots of tax revenues.

In the 90’s you had the internet boom, and the tax revenues from capital gains taxes. The states especially made out well from capital gains taxes from the sales of stocks, which then really hurt them when the market went south in 2001. In the 90’s you had the deficit reduction perfect storm; there was gridlock in the federal government with the repubilicans holding congress, and a democrat president, so not a lot of huge spending initiatives went through, interest rates and inflation were low, and there was a huge stock market boom.

We will survive this deficit build up this time too, if the following hold true:

  • The US economy and the productive part of the US population continues to grow. This is very important for raising revenues. Immigration is predicted to kept rising, and each new person will contribute to the US economy (most immigrants can’t get social services). Immigration may be the only thing that actually pays for the baby-boomers retirements.

-The US increases it’s investment in basic R&D. Unless we can continue to be innovators, the economy is going to fall. We might have the best Entrepreneurial business climate in the world, but unless we have ideas we aren’t going anywhere.

-We figure out what we are going to do about Healthcare. I believe it was Krugman that pointed out a few weeks ago that it isn’t social security itself that we can’t pay for, but it’s the increase in medicare expenses associated with the retirees that we can’t pay for. Without counting healthcare costs, the social security trust fund is still solvent. Of course this is going to require some sacrifices. Do we pay more for services through hirer taxes, or do we start rationing? Personally I’m willing to pay more, but most people aren’t. Of course this always brings into account drug costs, and the snake pit that drug costs are.

-Move up the age when one can start collecting social security. Lets face it, Gen Xers will have to wait until 70 to retire.

Remember, economic cycles still exist, and things tend to swing either way very quickly. What’s hurt US morale the most is that we have had a jobless recovery, mostly caused by increased productivity. This too can not go on forever, soon we will all be caught up in another boom cycle. The key is to realize that we have to hold off on the spending for a while. Know when to put the credit cards away, and starting eating in… I think the powers that be in government may be realizing this now.

Two words: “means testing.” At some point in the near future (likely under the first post-Bush administration), a means-test will be applied to Social Security benefits, meaning that if you’re of a certain middle-classish level of wealth or above, you simply will be disqualified from receiving Social Security. For you, Social Security will just be another tax, namely the tax that allows the less well-off to cash in Social Security.

As you can see, this solution fixes both crises simultanously – reducing the dollar amount of Social Security payouts, while also “creating” a “new” tax to defray what payouts are still made.

(More abstractly speaking, the means-test solution solidifies an economic shift already well underway – the migration from Social Security to personal investments as the primary engine for retirement wealth.)

P.S. I realize posts like mine are much less fun to read than the QT3 econ-doomsday harangues from folks like Jessica. So keep up the good work.

Karen, my point is that we’re living in la-la land on health care. Reasonable growth projections show an ever-expanding deficit unless someone fixes it, and there’s no sign of that on the horizon.

The GOP will approve a tax increase right after hell freezes over, and I really don’t think the public will put up with cuts in Medicare & Social Security. So we’re just kind of floating along pretending the problem will go away.

We’re basically looking at permanent deficits of 4% of GDP or so, forever.

Edit: I’d be for means testing, but again, this is something the GOP would let happen over their dead bodies.

The Asian countries all had fixed exchange rates of some variation, the key element in any financial crisis.

We aren’t likely to collapse, the problems we might be in are going to happen more gradually.

And I agree with Morris. We’ll just gradually move down the top line of how well-off you have to be to get SS until we are back in reasonable balance.

How would means testing be any different from a huge tax increase? So why not just adjust the tax rate and keep core social programs universal? I don’t understand this way of thinking at all. We’ve got major problems with the health care system, millions of people aren’t covered at all or have inadequate coverage, and a greying population that will soon be clamoring for Social Security cash–so, hey, let’s cut all those benefits (means testing would undoubtedly be set at a point so low that only the poorest people would still qualify for SS, so in essence it would turn into an extension of welfare) to attack the deficit!

If that’s not the recipe for massive social unrest if not open revolt, what is? How far can you push people before they finally say “You know, fuck it. I’m sick of being an indentured servant for these rich bastards!” and head off to the nearest gated community? The US is too volatile and too, um, heavily armed for major economic changes like this to go without causing serious fireworks. Big problems are coming if the system doesn’t right itself and reintroduce basic elements of fairness. Government has been co-opted by a clique of ruling families and associated interests who are making policy decisions that benefit a slim minority of people at the top. That’s always been the case, of course, but the past few years this has gotten ridiculously extreme. Thankfully, as history has shown us, governments can only get away with doing that for so long.

Actually you didn’t mention healthcare in your first post, but I would agree that healthcare is the big 300 lb gorilla that no one wants to look at. However, healthcare is not going to stay in the closet forever. I would wager that how we pay for healthcare in the US is going to radically change in the next 10 - 20 years. We as a nation are going to have to make some very difficult decisions on healthcare, and it will happen sooner than later.
Businesses (especially the small ones) are complaining about the yearly 10, 20, 30% rises in insurance costs. They raise their healthcare program cost to employees. Some employees op-out, and either go without or join state sponsored programs. I believe you posted the link to the article about Walmart employees being the biggest user of one state’s sponsered medicaid plan. Personally that pisses me off more than anything, since it just feeds the whole vicious circle. Here in NY state, the counties are required to pay half of the medicare costs for that county. This is the main reason that many of the counties are broke and inacting large property tax increases. The screaming has begun, and the issue won’t remain hidden much longer.
I guess my point is, all of this isn’t Doom and Gloom, we will have to face it sooner than later and we will face it. In some way it is the successes of the 20th century catching up with us. People are living much longer, and living that much longer requires more, and more expensive maintenance. And this maintenance is expensive…

Actually you didn’t mention healthcare in your first post, but I would agree that healthcare is the big 300 lb gorilla that no one wants to look at. However, healthcare is not going to stay in the closet forever. I would wager that how we pay for healthcare in the US is going to radically change in the next 10 - 20 years. We as a nation are going to have to make some very difficult decisions on healthcare, and it will happen sooner than later.
Businesses (especially the small ones) are complaining about the yearly 10, 20, 30% rises in insurance costs. They raise their healthcare program cost to employees. Some employees op-out, and either go without or join state sponsored programs. I believe you posted the link to the article about Walmart employees being the biggest user of one state’s sponsered medicaid plan. Personally that pisses me off more than anything, since it just feeds the whole vicious circle. Here in NY state, the counties are required to pay half of the medicare costs for that county. This is the main reason that many of the counties are broke and inacting large property tax increases. The screaming has begun, and the issue won’t remain hidden much longer.
I guess my point is, all of this isn’t Doom and Gloom, we will have to face it sooner than later and we will face it. In some way it is the successes of the 20th century catching up with us. People are living much longer, and living that much longer requires more, and more expensive maintenance. And this maintenance is expensive…

Well, I meant government healthcare - medicare. What the private sector is going to do about their share is another question.

How would means testing be any different from a huge tax increase?

It really isn’t. That was kinda my whole point.

So why not just adjust the tax rate and keep core social programs universal?

Well, we’ll probably do that also. And I’d argue that we need to greatly expand our core social programs, namely some form of universal minimum health coverage.

But understand that “deficit reduction” and “universal social programs” are two different issues. We can alleviate or negate the pending boomer-deficit by a means test of Social Security. Resolving the health care crisis is another (and arguably worse) problem.

We’ve got major problems with the health care system, millions of people aren’t covered at all or have inadequate coverage…so, hey, let’s cut all those benefits…to attack the deficit!

Calm down, my friend. You’re hallucinating policy statements. The debate over health care reform is a matter of what and how, not whether, and none of the serious proposals involve cutting health benefits. There are several excellent long-term proposals gaining consensus, many of the details of which can found in any of the health-care position statements on Kerry’s campaign website.

I hallucinate a lot of things. But what has Greenspan been advocating, then? Sounds like cuts to me, and I’m sure he’s not a lone voice in the wilderness. The whole US system right now seems like it’s intentionally, insanely, gearing up to demolish the middle class with these sorts of changes. I also know that any sort of means testing would have to do much more than just cut out the rich folks to have a significant impact on the deficit numbers. The cynic in me says that, once again, a reasonable proposal would be twisted so that it hurts more people than it helps, or, like the recent medicare bill scam, will be more of a stunt than a policy change that really helps people. And will of course include lots of little things below the surface–like the privatization stuff in said medicare bill–that ensure the poor get good and soundly fucked by big business, yet again.

BTW, why do you think that “health care reform is a matter of what and how, not whether”? What indicators show that this is a certainty? Kerry can propose whatever he wants on his web site, but he hasn’t been elected yet. And Clinton went through this shell game over a decade ago, and the situation hasn’t much changed despite his determination to provide a universal health care system.

I also know that any sort of means testing would have to do much more than just cut out the rich folks to have a significant impact on the deficit numbers.

You’d be surprised, actually. If I remember correctly, eliminating benefits for $100k+ makes SS solvent until 2075 or something.

Let’s not live in a fool’s paradise here. Comparing the percentage of national debt and deficits to the total GDP is essentially meaningless. The government doesn’t tax GDP; it takes income on individuals and businesses and levies tariffs and taxes on sales and imports. About 45% of the revenue collected annually is in income tax; the rest is in corporate taxes, tariffs and other taxes (such as the 55 cents per gallon tax on gasoline). For 2004, that will amount to about $700 billion in income taxes and a roughly similar amount in other taxes and tariffs. Businesses will pay the least amount of that total. What is meaningful here is the amount of torque placed on the system by the debt.

Eventually, the national debt will come home to roost. These are checks the country is going to have to cash eventually. It is already costing us between $200 billion and $300 billion annually in interest payments alone and it is growing every year. More than $400 billion in deficits are planned for fiscal 2004; there’s another $5.6 billion or so in annual interest starting this year. And remember, that doesn’t even touch the principle; that $7 trillion just sits there, generating interest payments. Over the last 20 years, we’ve paid out more than $3 trillion in interest payments. In this decade alone, we will pay another $2.5 to $3 trillion.

On top of that, the country owes more than $1 trillion to the Social Security fund; that’s the amount Congress has “borrowed” from it over the last 20 years or so, issuing Treasury Bonds as security. This is nothing more than kiting checks, since those bonds have to be paid for by tax revenues. This trend continues because Social Security has a surplus every year, which Congress wraps into the general fund and spends. Raising the entry age for benefits means nothing unless that practice is stopped. Social Security could be solvent today if Congress stopped robbing Peter to pay Paul and started making even minimal payments of what it owes back into the fund.

Cost reduction would have some effect, especially if it resulted in zero deficits or a surplus. The reductions, however, have to be permanent and the debt has to be paid down to have a lasting effect. Without that, this is simply an exercise in passing the buck to the next generation. Every kid born today already owes several thousand dollars to the government as his or her share of the national debt and that amount is growing every year. Our grandkids are already living in poverty; they just don’t know it yet.

In the midst of all of that, we reduce the taxes paid by corporations on the theory that they will then create more jobs, which will provide more tax revenue from incomes, and reduce or waive tariffs to be part of the world economy, on the theory that we’ll make it up in exports. Except that it isn’t working; our trade deficits grow every year and more jobs are lost every month in this “jobless recovery” to increased productivity, automation and outsourcing (relatively small now, but growing).

The unemployment rate continues to grow slowly on the trend line, but even that doesn’t tell the whole story. Somewhere between 2 million and 5 million people have just stopped looking and fallen out of the system (the number used depends on who is doing the talking). Adding even the lower number to the unemployment rate would jump it from the current approximate of about 5.6% to nearly 8%. If you accept the higher number, then we’re talking an unemployment rate of nearly 12%. That would be halfway to the numbers we saw in the Great Depression, at a time when we’re supposedly not even in a recession.

I don’t think we can live with half-measures here. We’re not at the breaking point yet, but we’re not all that far away from it, either. If the government doesn’t stop living beyond it’s means and pay it’s debts, in less than 20 years we could all easily be well and truly screwed.

Maybe, but I doubt it. That’s a LOT of money, even for the US. They will realize (if they haven’t already done so) that repaying it is too difficult, too many sacrifices will have to be made, too many politically unpopular sacrifices.

Annulment may well be the solution. If the US can take over the world by means of culture and finally governmental control, their debt can either be annuled or the tax base can at least be expanded to the world’s population. What’s easier… doing this or getting the US populace to pay back $7 Trillion?

Yeah, because the more Britney CDs we ship abroad the more those pesky Europeans are willing to let us tax them. Makes perfect sense.

You know GDP is mathematically identical to “total income”, right?

How come the national debt didn’t “come home to roost” in the 1950’s or 1990’s?

In 1943 the national debt was 30.3% of GDP, in 1983 it was 6.0% of GDP, in 1992 it was 4.7% of GDP. None of these caused massive economic catastrophies.

In 2003 the national debt was 3.5% of GDP. This year it is estimated (probably wrong) to be 4.5% of GDP. See http://www.gpoaccess.gov/usbudget/fy05/hist.html for details.

I would agree that we should be taking the national debt seriously. I’m a Concord Collalition type of gal. However I don’t think the sky is going to fall and western civilization is going to end because the US has reached high decifit levels yet again. One thing to remember is that about 3/4 of the current yearly deficits are caused by the Bush tax cuts. Taxes have been raised before to cut decifits and they can and will be raised again, especially since most of the Bush tax cuts have expiration dates on them.
Large deficits make things uncomfortable, they can possibly raise taxes, interest rates, and stiffle economic growth, but they are not the end of the world. If they were the US would have become an economic backwater years ago.