Thoughts on the national debt

News stories today are reporting that as of the end of December, the national debt has passed the $14 trillion mark. Technically that's not true, since $4.6 trillion of that amount is debt that the federal government owes to itself (e.g., money which Treasury has "borrowed" from social security), according to Treasury. Our debt to other parties currently totals $9.4 trillion, which works out to about 63% of GDP, and it has risen by more than $3 trillion since Q3/08.

I'm not trying to belittle the deterioration in our fiscal health, just trying to be more precise. Social security payments are not the same sort of obligations that are incurred when Treasury sells a bond. If Treasury were to default on its debt obligations, that would be very serious indeed, since Treasury debt is the bedrock of the world's financial system. But our national government can change the future payout of social security in ways that could drastically reduce the future unfunded obligation of that program (which, I reminded one of my nephews last night, is one of the worst scams ever perpetrated on today's young people—he would be far better off if he were allowed to direct his FICA contributions to a private investment/retirement account). Two very easy solutions that would make a world of difference: raising the retirement age, and adjusting future payments for the CPI instead of using the rise in incomes (which includes a real component in addition to inflation). If in addition to these changes we were to follow the example of Chile and allow people to opt out of social security voluntarily, in exchange for directing their own (mandatory) contributions to a private investment account, the social security problem might fade into relative obscurity before too long.

And since Medicare represents a huge potential unfunded liability, we could deal with the lion's share of that by simply changing the tax code to treat health insurance costs the same, whether one gets his insurance from an employer or pays for it out of his own pocket. Just let everyone deduct the cost of healthcare, or no one. That would soon result in a reversal in the decades-long march towards a system where today a third party pays for most people's healthcare costs. When someone else is paying the bill, you have very little incentive to shop around or otherwise cut costs, and competition among healthcare providers never gets much of a chance to make the healthcare market more efficient.

In any event, the chart at the top compares the burden of our national debt to the level of long-term bond yields. I've long been fascinated by this chart, since it shows what appears to be a very non-intuitive relationship: as the burden of our debt fell from WWII through 1980, interest rates rose; and as the burden of the debt rose from 1980 on, interest rates generally fell. The theory that government debt "crowds out" private debt by pushing interest rates higher just doesn't hold water according to this chart. The main determinant of interest rates, of course, is inflation, and there is no necessary connection between the amount of Treasury debt and the level of inflation. Unless, that is, the Federal Reserve decides to monetize the debt....  We may discover in coming years just how this works, now that the Fed has quasi-monetized almost 10% of our national debt. This will be the focus of intense interest over the next few years.

UPDATE: For more on federal deficits and how relatively easy it should be to balance the budget, see my posts here and here.