Tuesday, July 14, 2015

Federal debt burden stops rising

This post is a followup to yesterday's post, in which I noted the dramatic reduction in the federal budget deficit, which is now only about 2.2% of GDP. Thanks to this, and given that the growth of debt outstanding (3.6% in the past year) is now less than the growth of nominal GDP, which is probably rising about 4% per year, the burden of our federal debt (i.e., debt outstanding as a percent of GDP) has stopped rising. If current trends continue, the federal debt burden is unlikely to rise further and could even decline marginally, to roughly 72%, between now and the end of the Obama administration in early 2017.

The bad news is that our debt burden has doubled in the past seven years, and that has never happened before during peacetime.

The chart above shows the nominal level of federal debt held by the public, currently $13.1 trillion (this includes the Fed's holdings of $2.5 trillion of Treasury debt). Total public debt outstanding currently is $18.2 trillion, but that figure includes intergovernmental holdings of $5.1 trillion, which is mostly debt that the government "owes" to the Social Security system. For many years, the federal government has used Social Security surpluses as if they were general revenues, spending the money and maintaining the fiction that it was borrowed. 

The chart above shows the burden of federal debt that is owed to the public, which is simply debt outstanding divided by nominal GDP. That is the best measure of how onerous our debt burden is. The current level of federal debt outstanding is about 73% of GDP, which is roughly equivalent to saying it would take about nine months of everyone's work to pay off the debt.

The chart above takes changes in the federal debt burden over time and assigns them to presidential administrations beginning with Nixon. The red bars indicate increases in the debt burden, while green bars represent periods in which the debt burden fell. Note that the increase in the country's debt burden during the Obama presidency has to date been about 26 percentage points, almost as much as the net debt burden accumulated by all presidents prior to Nixon (29 percentage points).

When as a nation we borrow money to finance our federal debt, what matters most is not how much we borrow, but what we do with the money we have borrowed. (Recall Milton Friedman's admonitions that "spending is taxation." All money spent must eventually be paid for by taxes, either directly or indirectly, even if it's financed initially by debt.) Debt that is used to finance productive investments can pay for itself by boosting incomes and creating new jobs (e.g., infrastructure, research). But debt that is used to finance consumption is money that is squandered—Greece comes to mind as a good example of what not to do with borrowed money.

As the chart above shows, almost three-fourths of all the money spent by the federal government is now in the form of transfer payments—that is, taking money from those who work and giving it to those who don't work. In the year ending last May, the federal government sent out checks totaling over $2.6 trillion to people who were "entitled" to the money for various reasons (e.g., they were retired, they received food stamps, welfare, disability insurance, etc.), meaning they did nothing in exchange. Very little of what the federal government spends goes to productive investments.

Since most of the money our government borrows does nothing to enhance the underlying strength of the economy (supporting consumption does nothing to grow the economy), our federal debt burden is a serious and a significant fraction of GDP. Servicing that debt currently requires only about 2% of GDP per year, but that will rise as interest rates rise and it could become quite problematic at some point. The cost to the federal government of rising interest rates will be mitigated substantially, however, since Treasury has for years been extending the maturity of its outstanding debt. This has "locked in" historically low borrowing costs for quite some time. It's a zero-sum game, however, since whatever Treasury saves by having borrowed a low, fixed rates, the holders of Treasury debt will lose as rates rise. Rising inflation—which would almost certainly cause interest rates to rise even more—could "bail out" the government by reducing the real burden of the debt, but again at the expense of the public.

As a counterweight to the sizable burden of public debt, I note that household debt service burdens are historically low, and household leverage has fallen significantly in recent years.

At least for now it looks like the federal debt situation won't get any worse. Before too long, however, things could get ugly unless there is some serious effort to reform entitlement programs. The best long-term solution would be to restrain the growth of spending, reform entitlements (e.g., raise the social security retirement age, adjust the indexation formula, and means-test benefits) and adopt policies (e.g., lower marginal tax rates, lower regulatory burdens) that increase the private sector's incentive to work and invest, thereby causing the economy to grow faster and thus reducing the burden of debt.

It's my hope that, with social issues now largely off the table, and with federal deficits back down to manageable levels, the debate leading up to next year's elections will focus the electorate's attention on sensible, growth-oriented policy solutions.


Benjamin Cole said...

I agree, and "national security" spending is also run away. As David Stockman has pointed out, the US now spends double in real terms on so-called national defense than we spent at the height of the Reagan years.

If one puts together to the budgets of Defense, DHS, the VA, and the black budget, it comes to about 1 trillion dollars a year.

In addition this large military ability seems to encourage U.S. presidents Democratic and Republican to engage in folly overseas, in interminable but fantastically expensive and inconclusive wars.

William said...

To me, there is nothing more wasteful in the US budget than the weapons purchase expenditures in the Pentagon budget which the Pentagon doesn't want but congressmen force through to keep constituents / corporations happy in their districts.

And the funding of Military bases which the Pentagon doesn't want but congressmen want and barter for and keep in the Pentagon budget again for purely political reasons - like being re-elected.

Johnny Bee Dawg said...

Why do you show the debt burden listed by President? All spending bills must originate in the House. Why not show the debt burden listed by who controls Congress? If you notice, things have gone much better with a PUB Congress. In fact...the difference is as stark as night and day. Check out how the percent of debt to GDP fell while PUBs controlled Congress from 1994-2007. The deficit, as a percent of GDP finished at less than half its previous 50 year average. Spending rose, but we had the GDP to pay for it. The only pause was when the Senate was tied from 2000-2002. Stocks didn't like that. Things also went well when PUBs controlled Congress throughout the 1950s, too.

We The People packed the House of Reps with Tea Partiers in 2010 and 2012, who forced the first annual decrease in government spending in 2013 since WW2. Probably just a coincidence that stocks had one of their best years, then, too.

I don't really care who your President is, as long as we have a PUB Congress. I think a graphic showing that should be included.

Johnny Bee Dawg said...

In the early 1950's National Defense still accounted for about 70% of Federal spending, and Payments to Individuals accounted for only 15% or so.

Today, those two numbers have flip flopped.
I don't mind spending about 5% of GDP on National Defense. It used to be triple that number.

Benjamin Cole said...

A businessman spends a little as prudent---not a fixed ratio, regardless of need. Anyway the defense budgets today are mostly patronage or these insane foreign entanglements.
Maybe time to sunset the whole military and start fresh....

Cut welfare cut warfare.

Scott Grannis said...

Johnny Bee Dawg: I like your suggestion re showing the debt burden by changes in Congressional control. I'll work on it. Thanks

Nick Thorne said...

G'day Scott,
Could you please explain to me why you have a debt to GDP ratio of 72% whilst on usdebtclock.org it is 102%? What am I missing?
Cheers mate your posts are legendary.

Scott Grannis said...

Nick: I explain this in the third paragraph of the post. They are using Total Public Debt Outstanding, which includes about $5 trillion that the government owes to itself. It's more accurate to use Debt Owed to the Public, which is $13.1 trillion, or 73% of GDP.

William said...

Scott, to pursue Nick's question further. Why is it more accurate to exclude the "$5 trillion that the government owes to itself"? Doesn't the $5 trillion still have to be repaid from taxes on US citizens, especially since the government borrowed from the Social Security Trust Fund to use for daily operations.

You have quoted Milton Friedman to the effect that "all government spending is a TAX" since ultimately the citizens must be taxed to repay any debt.

I admit that 72% of GDP sounds much better to the masses than 102%. ;~)

Benjamin Cole said...

Round numbers (I have not checked lately) the U.S. Federal Reserve also owns $3 trillion in Treasuries, the interest upon which is funneled back into the US Treasury (minus a cut for the very large Fed staff and apparatus).

Scott Grannis says the Fed is not part of the US Government, so the Fed hoard cannot be considered to be money the government owes to itself. This may be parsing matters a bit finely, although I do understand the history of the Fed and its current self-funding (not financed by taxpayers).

In any event, the Fed could merely roll-over on its board indefinitely, and taxpayers would never have to pay off the $3 trillion, and interest payments will continue to be funneled back into the Treasury, a small respite for taxpayers.

So the federal debt to GDP ratio would be even lower, in effect.

BTW, the Bank of Japan has been paying down national debt too, through QE. Japan's national debt to GDP is some horrific figure, such as 200%. Despite sustained QE, Japan is still falling below modest inflation targets, though its economy is recovering nicely, and its stock market has done well, with QE.

As a practical matter, there is a lot to like about QE. It seems to work. It pays down national debt, it stimulates the economy, it does not seem to result in high inflation.

For some reason, QE has become an ideological, or even semi-religious issue with some.

I say forget dogmas, forget ideologies, and go with what works.

Scott Grannis said...

William, re the correct measure of Federal debt:

Here's a very simplified explanation: Think of Social Security as being part A of the Federal government, and all the rest of the Federal government as being part B. Part B has incurred a deficit of $18 trillion over the years, but part A has incurred a surplus of $5 trillion. Taken together, the net position of parts A and B is a deficit of $13 trillion, and that is the amount which is owed to the outside world (e.g, US citizens, banks and foreign governments). In practice, the net inflows to Social Security have simply been dumped into the general fund, and used to pay the bills. In this manner, the SS surplus has reduced the need for Treasury to borrow from the outside world. In order to preserve the fiction of there being a Social Security "lockbox," Treasury has issued $5 trillion of notes and bonds and given them to SS in exchange for its surplus. None of this changes the fact that when SS begins to run a net deficit, the Federal government will have to come up with the money to make SS payments. When that happens, SS will "sell" its notes and bonds to Treasury and use the money to make its payments to beneficiaries. If the lockbox were done away with, nothing would change as far as the outside world is concerned.

So the true measure of what Treasury owes the outside world is $13 trillion, not $18 trillion.

William said...

Thank you, Scott, for replying to my question about "$5 trillion that the government owes to itself".

I truly appreciate your blog and the tremendous effort that you make to educate us. Thanks you for sharing your knowledge and professional experience with your us.

Hans said...

Excellent thread, Mr Grannis!

Welfare, is killfare for America's future..