Deficits (and Massive Debt Overhangs) DO Matter → Washingtons Blog
Deficits (and Massive Debt Overhangs) DO Matter - Washingtons Blog

Monday, November 23, 2009

Deficits (and Massive Debt Overhangs) DO Matter

The New York Times has a good essay on debt:

But that happy situation, aided by ultralow interest rates, may not last much longer.

Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.

Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means....There is little doubt that the United States’ long-term budget crisis is becoming too big to postpone.

Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.

The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.

For more on issues regarding age demographics, benefits and the tension between young and old, see this and this.

The Times continues:

“The government is on teaser rates,” said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits. “We’re taking out a huge mortgage right now, but we won’t feel the pain until later”...

The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security

The current low rates on the country’s debt were caused by temporary factors that are already beginning to fade. One factor was the economic crisis itself, which caused panicked investors around the world to plow their money into the comparative safety of Treasury bills and notes. Even though the United States was the epicenter of the global crisis, investors viewed Treasury securities as the least dangerous place to park their money.

On top of that, the Fed used almost every tool in its arsenal to push interest rates down even further. It cut the overnight federal funds rate, the rate at which banks lend reserves to one another, to almost zero. And to reduce longer-term rates, it bought more than $1.5 trillion worth of Treasury bonds and government-guaranteed securities linked to mortgages...

The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month, and they have announced plans to stop buying mortgage-backed securities by the end of next March.

Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels...

Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education...

The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead.

As Karl Denninger has repeatedly pointed out, we are on an unsustainable track guaranteed to lead to a debt crisis. Denninger posts the following chart to make his point:

Under any scenario, debt gets further and further ahead of GDP, and America slowly digs its own grave.

And as Tyler Durden noted on November 1st:
As the assets on the US balance sheet become increasingly long-dated, courtesy of QE, and locking in record low rates, US liabilities in turn have shortened their duration to a record level. Almost $3 trillion in US debt will have to be rolled by the end of 2010. If realistic inflation expectations are any indication, all hopes of getting comparable interest terms on these securities once refinancing time rolls around, will be promptly dashed (we are not saying inflation is inevitable, even with QE 2.0 around the corner). Yet for all who claim inflation is a good thing, the one security that will be hit the most and the fastest will be precisely the T-bill universe, once all the curve steepeners already in place unwind very, very quickly. The result would be a major spike in interest expense payments by the government. The chart below presents the historical annual interest expense on all USTs by year. 2009 will be the first year in which the interest expense alone will be over half a trillion dollars (Zero Hedge estimates).

The concern is that even as the US debt, which as of Friday was at $11,868,457,477,911.94, and looks like it will hit the $12.104 trillion limit within a few weeks, continues to skyrocket, the interest expense paid on holdings will continue creeping ever higher. Keep in mind, at September 30, the average interest rate on Bills was a historically low 0.347%, and Notes yielded a QE-facilitated 3.043%. With the Fed out, can China and US retail investors support this record low interest at a time when UST supply keeps coming and coming?

And as the Times points out, America is competing with other countries to sell debt:
The United States will not be the only government competing to refinance huge debt. Japan, Germany, Britain and other industrialized countries have even higher government debt loads, measured as a share of their gross domestic product, and they too borrowed heavily to combat the financial crisis and economic downturn. As the global economy recovers and businesses raise capital to finance their growth, all that new government debt is likely to put more upward pressure on interest rates.
Paul Krugman disagrees, believing that debt is a "phantom menace". But this is not because Krugman is a liberal. Government economists in the Reagan, Bush and Obama administrations have all believed pretty much the same thing: deficits don't matter.

But many experts disagree:
  • The St. Louis Federal Reserve Bank posted a paper entitled "Is The United States Bankrupt?". The paper provides the following answer: "The United States is going broke"
  • People seem to think the government has money," "said former U.S. Comptroller General David Walker. "The government doesn't have any money"
  • The United States Department of the Treasury and the Office of Management and Budget published a report stating that the U.S. cannot grow our way out of the government's liabilities, that the liabilities are quickly growing, and that failing to take drastic and immediate action would lead to very bad consequences (the report was written in 2006)
  • Nouriel Roubini writes:

    Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won't solve the debt overhang problem (Dr. Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn).
  • The International Monetary Fund - which oversees third-world economies - is so concerned about the solvency of the U.S. economy that, during the Bush administration, it started conducting a complete audit of the whole US financial system. The IMF previously only audited banana republics (then again ...)
  • Société Générale published a report titled "Worst-case debt scenario", in which the bank's asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems. "As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse," said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast. The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Aging populations will make it harder to erode debt through growth. "High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt," it said. The bank said the current crisis displays "compelling similarities" with Japan during its Lost Decade (or two), with a big difference: Japan was able to stay afloat by exporting into a robust global economy and by letting the yen fall. It is not possible for half the world to pursue this strategy at the same time.
  • The American Enterprise Institute for Public Policy Research (AEI) published a paper indicating that “by all relevant debt indicators, the US fiscal scenario will soon approximate the economic scenario for countries on the verge of a sovereign debt default.”
  • Obama told Fox news that the United States' climbing national debt could drag the country into a double-dip recession

Of course, all it takes is a quick read of Minsky or Keen to see that massive debt overhangs drag economies down into the abyss.

And see this.


  1. Well, no. The Japanese experience says not. Hint: Japan's problem was an remains toxic debt on the banks' balance sheets, impairing their capital, hence, their ability to lend. It's not a problem with government finance, and the Japanese government has enjoyed low interest rates due to deflation, while running debt amounting to 200% of GDP without the bond market giving a hoot.

    See Bill MItchell, Japan grows along with the hysteria

    Anyone who understands modern money knows why this hoopla about government debt is just fear-mongering. Don't fall for it.

    This disinformation is based on comparing debt in the non-government economy with government debt. They are completely unlike in that the federal government is sovereign provider of a non-convertible currency of issue, while households and firms are users of that currency. Therefore, the relationship is inverse rather than direct, and vertical instead of horizontal.

    The government provides its currency of issue by crediting bank reserves. Bank reserves are like demand account in the private sector and Treasuries are like time deposits (CD's). Switching between them is just a matter of entering some figures on a balance sheet.

    Or think of it this way. High powered money (physical currency and bank reserves) is like tiddlywinks. The government is the tiddlywinks factory. It can issue as many tiddlywinks as it pleases with no problem as long as the tiddlywinks don't exceed the products and services available for sale or inflation will result. But the government can always take tiddlywinks back as necessary to keep the nominal in balance with the real by taxation.

    The government need neither to borrow or tax in order to spend or satisfy its obligations. In fact, the US as the issuer of the world's reserve currency really has an obligation to supply as many Treasuries (time deposits) as needed by those who want to park their excess reserves in interest-bearing instrument that are equivalent to dollars.

    In a flexible rate system, if there were a problem interest rates would be rising and/or the dollar would be crashing. As a matter of fact, interest rates are at historical lows and the yield curve is flat. The dollar is under pressure but it is being driven down by the Fed in order to relate assets prices, in order to pump up the toxic waste on bank balance sheets, as well as to make US exports more competitive (a hidden tariff).

    All this BS about the Us becoming insolvent or defaulting on its debt is just straight BS or just ignorance of how the monetary system works

    See L. Randall Wray, Understanding Modern Money (1998), available at Google Books.

  2. Laurence J. Kotlikoff's paper on "Is the United States bankrupt?" has an excellent suggestion regarding reforming taxation by changing from an income to a retail sales tax. It lists the important benefits of:
    1. Poor households paying no sales taxes in net terms.
    2. Eliminating the regressive FICA tax which is 0% for earnngs over $90,000
    3. Taxing the wealth of the rich
    4. Saving hundreds of billions in compliance costs
    5. Encouraging savings
    6. Enhancing generational equity

    There are additional benefits of:
    1. Reducing taxation on domestic production which would increase domestic manufacturing employment
    2. Making our exports more competitive.
    3. Reducing the intrusion of government in personal financial matters which would increase personal liberty.

    It is simple, progressive and offers the above benefits. Why is there virtually no discussion of it's merits?

  3. Tom, sounds like how it is SUPPOSED to work. But since private banks create credit and money out of thin air, the American people end up paying a LOT of interest on debt. See:

  4. GW - keep up the great blog.

    Funny how Paul Krugman calls debt a phantom menace now that Obama is president. Yet he rails on Bush and Reagan for running up deficits. I guess for Krugman, the importance of deficits is determined by whether a Republican or Democrat is in the White House.

  5. Tom, you don't have to worry about US becoming insolvent. We are insolvent! Talk about an unsustainable business model. Rick Waggoner is alive and well and living in Washington DC.

  6. George, this is how it actually works. It is important to realize that the government and private banking system stand in a vertical relationship. That means that the federal government can and does add and subtract net financial assets to the economy by spending and taxation.

    The private banking system controls the money supply in that bank lending creates deposits (against which banks then are required to hold reserves. Reserves come after the lending not before). That banks lend to create deposits that the balance of loans and deposits always nets to zero. The private banking system cannot increase or decrease net financial assets.

    On the government can do increase the net financial assets of non-government by increasing reserve accounts. This done through government spending (including interest paid on Treasuries). Only the government can reduce net financial assets of non-government. This is done though taxation.

    Modern monetary theory is based on Abba Lerner's functional finance:

    "The central idea is that government fiscal policy, its spending and taxing, and its withdrawal of money, shall be undertaken with an eye to the results of these actions on the economy and not to any established traditional doctrine of what is sound and unsound." (Lerner, 1943, p. 39)

    HIs two principles of functional finance are:

    1. "The first financial responsibility of the government (since nobody else can undertake that responsibility) is to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce." (Ibid.)

    2. "An interesting corollary is that taxing is never to be undertaken merely because the government needs to make money payments.... Taxation should therefore be imposed only when it is desirable that the taxpayers shall have less to spend." (Ibid, p. 40)

    (Quoted in Wray, cited above, pp. 75-76)

    (continued below)

  7. (continuation)

    Neo-Chartalism expands on this in light of the change in the US monetary system on April 15, 1971, when President Nixon at the urging of Treasury Secretary John Connolly, then a Democrat, ended dollar-gold convertibility. (This did not cause either default or a dollar collapse, or a breakdown of the monetary system.)

    Since at point in time, the US government as a sovereign is not only not monetarily constrained, but also it is not constrained by convertibility or any fixed rate of exchange. This makes a whole world of finance possible of which progressives are not yet aware. As a result, they are struggling within an economic paradigm that does not reflect present reality. Nor is it likely to reflect future reality, because the world is not going back on the gold standard anytime soon, regardless of what Ron Paul thinks.

    Neo-Chartalism describes how the present monetary system works based on national accounting, with the government and non-government in a vertical relationship of currency issuer and user.

    Circuitism, as propounded by Steve Keen, for example, studies how money operates in horizontally the non-government system. Here it is vitally important to the health of the financial system that the financial system act responsibly in the fiduciary sense of putting other people's money at risk. Current laws and regulations did not limit that sufficiently, and there may also be violations of current laws and regulations that were not observed. See the work of William K. Black (an associate of Wray at the University of Missouri) on the latter. That is a separate issue, and it is what I believe you were primarily referring to above in your comment.

    It is vitally important that progressives understand these issues in terms of an economic paradigm that is reality-based. MMT is based on how the system actually works, explained in terms of national accounting identities that are common practice in the profession — not on economic models based on non-empirical assumptions, which are not borne out by facts. Otherwise, progressive will be suckered into a debate they cannot win because they cannot hope to counter sophisticated arguments of economists that appeal to complex mathematical models. See Steve Keen, Debunking Economics (2001).

    Moreover, it is vital over put an end to the erroneous and misleading analogy that equates government and household finance when they are actually opposites, issuer and user. There is simply no parallel, since the government is not revenue-constrained while households and firms are.

    As you say, households pay a lot of interest on debt. That is to the banks and is a horizontal relationship. Where government enter into it is in forcing people to go into debt by not injecting enough money into the economy in the first place (the Clinton surpluses) or by not redistributing wealth through progressive taxation when wealth accumulates at the top. But this has nothing to do with government borrowing.

    Governmment borrowing is, in fact, unnecessary. Randy Wray is recently out with a blog post for the government to just stop borrowing and monetize directly in order to end this ridiculous and needless handwringing over the "unsustainable national debt."

    Memo to Congress: Don't Increase the national debt limit.


  8. It's simple Math, spend more than you take in and.....
    We have built up 12 trillion dollars of debt in less than 30 years. It is the baby boomers selfish debt. They should pay it off before they pass on.
    Yes, that means raising their taxes and paying down the debt. Did they really think there is a free lunch? Do we really think we can cut taxes and still keep government services?
    When the politicians run on "No New Taxes" pledge, why didn't they also say, but we will have to cut Social Security, Defense spending, and every other department of government.
    By what right do they keep future American generations in deep debt, and stunt their ability to make decisions to move the country forward.

  9. Tom is of course right.

    The only remaining problem is a kinky one however.

    It is not capitalism. It is not capitalism, and will in fact destroy capitalism because the emphasis ends up politics, -not business.

    You cannot raise beef in the parlor.

  10. "It's simple Math, spend more than you take in and....."

    This is the classic mistake that everyone makes about government finance and household finance being similar. This relationship does not hold because the government is the issuer of currency, not the user.

    The government issues into the non-government economy by its spending. The government does not borrow or tax to spend. Taxes are used to withdraw net financial assets. That is all. Borrowing is paid off simply by crediting an account, nothing more.

    This is so simple, it is hard to get. But it is true. It is simply the way that a fiat money system works. The government cannot "run out of money" in a fiat system. When money creation outpaces the capacity of the economy to produce goods and services to buy, then the government slows spending and takes money out of the economy through taxation to maintain the balance. It's that simple.

    Presently, the Fed is trying to do this through lowering interest rates and excess reserves, which doesn't work, especially in a liquidity trap such as the one we are in now. MOreover, Treasury is perpetuating the fiction that the government needs to borrow to spend. As a result, President Obama and the Democratic Congress are in dander of crashing and burning as they turn attention to the deficit instead of attending to unemployment. Shades of 1937 loom, as Krugman has been pointing out lately. If progressives pile on the deficit dove bandwagon, they can kiss the Democratic majority goodbye.

  11. Be careful what you link to - this is part of a large coordinated attempt to reduce Social Security benefits and impoverish the public.

    First the document says:

    "...that the government has cut taxes well below the bone..."

    and then they say:

    "If, for example, agents who face confiscatory lifetime fiscal burdens refuse to work, there will be no lifetime resources for the government to appropriate."

    Is code for:

    Don't raise taxes on the rich.

    (Since workers can't refuse to work, they need income to survive, the only 'agents' who might go on strike would be the wealthy).

    So, the solution is:

    "...replace the current tax systems with a retail sales tax, personalize Social Security, and move to a globally budgeted universal healthcare system implemented via individual-specific health-insurance vouchers."

    Realize that the "new world order" many feat is being advocated by the document you are using to justify your thoughts on government debt.

    Now, the US administration is NOT using the financial resources at its command correctly - but this is not because of any debt being incurred. They are failing to spend sufficiently to create jobs and income. That is the issue - not debt repayment.

    If the Chinese don't want to purchase Treasuries with their excess dollars they can keep them in a Great Mattress, or they can spend them globally - which will return those dollars to the US for goods/services and assets and stimulate the US economy. But the Chinese lose the peg if they do that.

    So the Great Mattress is their only strategy outside of buying Treasuries until their domestic economy grows sufficiently - about a decade at least.

    Don't buy into this meme that the US is going to go bankrupt - it is the biggest head fake to justify the largest rollback of public wealth in history.

    BTW, since bank money is created with a corresponding offset (asset/liability), where do think the money comes from to create free-and-clear property ownership?

    The government must create it by spending - there is no other source to "pay the bank interest" or create net financial assets ("things" that are worth something and have no private debt attached to it).

    The public debt is a proxy for the total generated wealth of the country not encumbered by private debt. Pay off the public debt and the ONLY source of money becomes the banks (or foreign sources).

    Is that what you really want?

  12. Thanks Tom Hickey

    You've obviously been visiting Mr Mitchells and Mr Wrays sites as well. The level of ignorance regarding debt amongst the mainstream media and economists is staggering. Hearing folks talk about "defaulting" or going bankrupt is patently absurd.

    Learning how our fiat monetary system actually operates should be a prerequisite before you are permitted to talk about macroeconomics on TeeVee. Its really quite exasperating to listen to these morons.

    I was drawn to this article because of its title and was pleasantly surprised to see yours as the first response.

    Keep fighting the good fight.

  13. I think what you forget Tom is that as they create more money it becomes less valuable. With the U.S. dollar being the world reserve currency this upsets many people and risks them dropping it, which is part of the reason the Iraq war happened.

  14. I'm really eager to learn more about this and how the possible US debt crisis will affect me, but I would like to ask the Progressive poster who seems not to be alarmed about this the following question -- If sovereign debt isn't a problem then what is happening in Greece right now. Can't they just print more money to get themselves out of their crisis?

  15. Tom,
    You keep saying things like "The government must create it by spending", and "The government issues into the non-government economy by its spending. The government does not borrow or tax to spend", and "The government need neither to borrow or tax in order to spend or satisfy its obligations. In fact, the US as the issuer of the world's reserve currency",

    Yet, the government is separate and, as you say in a vertical relationship to the central bank ( which is private). So for the government to do all those things you say they can, they must print ( or issue) currency or the equivalent- call them credits if you like. Just like Iceland did. However,the Central Bank is really in the drivers seat, with the Constitutional authority to issue currency ( or ledgered credits if you prefer), NOT the US government. The US government can only either borrow and re-lend/spend, or tax and spend.

  16. "This is the classic mistake that everyone makes about government finance and household finance being similar. This relationship does not hold because the government is the issuer of currency, not the user."

    Kruschev, Kosygin and Brezhnev tried this in the Soviet Union to fund their war machine. Worked for a little while, till people started starving and no one would trade their grain and machine tools for Soviet oil and gas anymore.


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