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U.S. Public Debt - Nov. 29/07

posted on Dec 02, 2007 05:21AM

United States public debt

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The United States public debt, commonly called the national debt, gross federal debt or U.S. government debt, is the amount of money owed by the United States federal government to creditors who hold U.S. Debt Instruments. As of November 29, 2007, the total U.S. federal public debt held by the public was $5.12 trillion.[1]

This does not include the money owed by states, corporations, or individuals, nor does it include the money owed to Social Security beneficiaries in the future. If money borrowed from the Social Security Trust Fund is included, as well as borrowings from other accounts already funded by US taxpayers, the debt figure rises to over $9 trillion.[2][3]

It is important to differentiate between public debt and external debt. The former is the amount owed by the government to its creditors, whether they are nationals or foreigners. The latter is the debt of all sectors of the economy (public and private), owed to foreigners. In the U.S., foreign ownership of the public debt is a significant part of the nation's external debt (see also below). The Bureau of the Public Debt, a division of the United States Treasury Department, calculates the amount of money owed by the national government on a daily basis.

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[edit] Calculating and projecting the debt

Tracking current levels of debt is a complex but rather straightforward process. Making future projections is much more difficult for a number of reasons. For example, before the 9/11 attacks the Bush Administration projected that there would be a $1.288 trillion surplus from 2001 through 2004 in the 2002 U.S. Budget. In the 2005 Mid-Session Review, however, this had changed to a projected deficit of $850 billion, a swing of $2.138 trillion. Table 7 in this latter document states that 49% of this swing was due to "economic and technical re-estimates", 29% was due to "tax relief", and the remaining 22% was due to "war, homeland, and other enacted legislation". Reasons for the inaccuracy of future projections include economic growth being different than projected and changes in fiscal policy (tax cut and War on Terror).

In extra, projections between different groups will sometimes differ because they make different assumptions. For example, an August 2003 CBO document projected a $1.4 trillion deficit from 2004 through 2013. However, a joint analysis put out by the Center on Budget and Policy Priorities, the Committee for Economic Development, and the Concord Coalition a month later stated that "In projecting deficits, CBO follows mechanical 'baseline' rules that do not allow it to account for the costs of any prospective tax or entitlement legislation, no matter how likely the enactment of such legislation may be". The analysis added in a proposed tax cut extension, AMT relief, prescription drug plan, and increases in defense, homeland security, international, and domestic spending. This raised the projected deficit from $1.4 trillion to $5.0 trillion. Hence, the assumptions on which the projections are based are also very important.

Despite the drawbacks of making future projections, however, a responsible government must arguably make long-run projections so it can prepare the country for future possibilities. The federal government does provide long-run budget projection in Table 13-2 on page 209 of the Analytical Perspectives of the 2006 U.S. Budget. It projects that the federal debt held by the public will reach 249 percent of GDP in 2075. This is more than double the maximum reached during World War II and nearly four times its current level. Most of this increase is due to projected increases in entitlement spending and the resulting interest on the debt. It is worth noting that this is a projection, not a prediction. This projection assumes normal economic conditions and that government policies will follow current law. The stress of a quadrupling of the debt would likely cause one or both of these items to change.

[edit] The mechanics of U.S. Government debt

When the expenses of the U.S. Government exceed the revenue collected, it issues new debt to cover the deficit. This debt typically takes the form of new issues of government bonds which are sold on the open market. However, the debt can also be monetized by which the Federal Reserve creates an entry on its books to credit the US Government for an amount equal to the dollar amount of the bonds the Federal Reserve is acquiring. The money created in this process not only includes the new dollars that came into existence just to purchase the bonds, but much more because this new money is now sitting in the form of checkbook money at the Federal Reserve. Under the scheme of Fractional Reserve Banking this new checkbook money is treated as an asset to lend against. Economists estimate the expansion of the money supply as being many times the amount of the initial money created with the exact amount of the expansion being a function of the marginal propensity of the consumer to consume (rather than save) each new dollar.[4][5]

The ultimate consequence of monetizing U.S. debt is that it expands the money supply which will tend to dilute the value of dollars already in circulation. Thus, expanding the pool of money puts downward pressure on the dollar, downward pressure on short-term interest rates (the banks have more to lend) and upward pressure on inflation. Typically this causes an inflationary boom that ends in a deflationary bust to complete the business cycle. Note that money supply expansion is not the only force at work in inflation or interest rates. United States Dollars are essentially a commodity on the world market and the value of the dollar at any given time is subject to the law of supply and demand. In recent years, the debt has soared and inflation has stayed low in part because China has been willing to accumulate reserves denominated in U.S. Dollars. Currently, China holds over $1 trillion in dollar denominated assets (of which $330 billion are U.S. Treasury notes). In comparison, $1.4 trillion represents M1 or the "tight money supply" of U.S. Dollars which suggests that the value of the U.S. Dollar could change dramatically should China ever choose to divest itself of a large portion of those reserves.[6][7][8][9] [10]

The US budget deficit has been declining for the last three years and the Congressional Budget Office projects a surplus by 2012. [11] When the U.S. Government has a surplus, it may pay down its outstanding debt. It does this by paying back the principal of the outstanding bonds redeemed for payment while not issuing new bonds. The U.S. Government could also purchase its own outstanding securities on the open market if it was searching for a way to use a surplus to reduce outstanding debt that was not due for redemption in a given year. [4] [5] In recent years, the US trade deficit has reached roughly 6% of the GDP, a level former Federal Reserve Chairman Paul Volcker calls unsustainable.[12]

[edit] Arguments against paying down the national debt

The government may be able to avoid this consequence by instead focusing on expanding its GDP and thereby "reducing" the percentage of GDP that debt represents. The hope is that the deficit spending that increases the debt will increase GDP by a greater amount, and thus — in relative terms, at least — the debt would decrease. This worked to great effect in the U.S. between the end of World War II and 1980, even though the debt showed a net increase in absolute value over the same period.[13] Kenneth L. Fisher's recent article "Learning to Love Debt" is a good representation of the argument that "more debt is good thing" because of after effects the resulting money creation will have on the economy.[14]

[edit] Risks

[edit] Risks to the US Dollar

By definition, international trade is the exchange of goods and services across national borders. Historically the currencies of nations involved were backed by precious metals (typically using some form of Gold Standard), which would cause a nation operating under a trade imbalance to send precious metals (economic goods in and of themselves) to correct any trade imbalances. In the current scheme of fiat money, the U.S. Government is free to print all the money it wants. Consequentially, the government cannot technically go bankrupt as any debtor nation can just issue more money to gain seignorage.[15]

If there is a gross imbalance between the amount of new money being brought into circulation and the amount of economic goods that are represented by an economy, then there is an unstable situation that can lead to hyperinflation.[16] This has been observed in smaller nations such as Argentina in 1989; the International Monetary Fund and World Bank try to end such crises by working with the problem country to institute sound economic policies and restore faith in the international community that the country can again service its debt with a stable currency.[17]

The interest rate offered on new bond issues is the one that clears the market. On December 13, 2006, the U.S. 30 year treasury note had a rate of 5.375%. Were investors to become concerned about the future value of the US Dollar, they would demand a higher interest rate on US bonds to compensate them for the risk they are assuming.[18]

In 2006, Professor Laurence Kotlikoff argued the United States must eventually choose between "bankruptcy," raising taxes, or cutting payouts. He assumes there will be an ever-growing payment obligations from Medicare and Medicaid.[19] Others who have attempted to bring this issue to the fore of America's attention range from Ross Perot in his 1992 Presidential bid, to Investment guru Robert Kiyosaki, and, most recently, David Walker, head of the Government Accountability Office.[20][21]

The Current Risks of the Dollar include, inflation and deflation.

[edit] Consequences of foreign ownership of U.S. debt

A traditional defense of the national debt is that we "owe the debt to ourselves", but that is increasingly not true. The US debt in the hands of foreign governments is 25% of the total[22], virtually double the 1988 figure of 13%.[23] Despite the declining willingness of foreign investors to continue investing in dollar denominated instruments as the US Dollar has fallen in 2007,[24] the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public.[25] About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China. In total, lenders from Japan and China held 47% of the foreign-owned debt.[26] Some argue this exposes the United States to potential financial or political risk that either banks will stop buying Treasury securities or start selling them heavily. In fact, the debt held by Japan reached a maximum in August of 2004 and has fallen nearly 3% since then.[27]

Last year, the central banks of Italy, Russia, Sweden, and the United Arab Emirates announced they would reduce their dollar holdings slightly, with Sweden moving from a 90% dollar based foreign reserve to 85%. [28] On May 20, 2007, Kuwait discontinued pegging its currency exclulsively to the dollar preferring to use the dollar in a basket of currencies.[29] Syria made a similar announcement on June 4, 2007.[30]

[edit] A brief history of the debt

See also: National debt by U.S. presidential terms

US Debt through time.

The United States has had public debt since its inception. Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly reported value of $75,463,476.52 on January 1, 1791. Over the following 45 years, the debt grew, briefly contracted to zero on January 8, 1835 under President Andrew Jackson but then quickly grew into the millions again.[31][32]

The first dramatic growth spurt of the debt occurred because of the Civil War. The debt was just $65 million in 1860, but passed $1 billion in 1863 and had reached $2.7 billion following the war. The debt slowly fluctuated for the rest of the century, finally growing steadily in the 1910s and early 1920s to roughly $22 billion as the country paid for involvement in World War I.[33]

The buildup and involvement in World War II brought the debt up another order of magnitude from $51 billion in 1940 to $260 billion following the war. After this period, the debt's growth closely matched the rate of inflation until the 1980s, when it again began to skyrocket. Between 1980 and 1990, the debt more than tripled. By the end of 2005, the gross debt reached $7.9 trillion, about 8.7 times its 1980 level.[34]

Year to
30 SeptemberU.S. Govt Debt
US$ billions [35] 1910 2.6 1920 25.9 1930 16.2 1940 43.0 1950 257.4 1960 290.2 1970 389.2 1980 930.2 1990 3,233.3 2000 5,674.2 2005 7,932.7 2006 8,507.0 2007 N/A

The Second Liberty Bond Act of 1917 created a debt ceiling. Whereas Congress once approved legislation for every debt issuance, the growth of government fiscal operations in the twentieth century made this impractical. (For example, the Treasury now conducts more than 200 sales of debt by auction every year to fund $4 trillion in debt operations.) The Treasury was granted authority by the Congress to issue such debt as was needed to fund government operations as long as the total debt (excepting some small special classes) did not exceed a stated ceiling. However, the ceiling is routinely raised by passage of new laws by the United States Congress every year or so. The most recent example of this occurred in September 2007, when the U.S. Congress agreed to raise the National Debt limit to $9.815 trillion.[36]

[edit] Debt clocks

In several cities around the United States, there are national debt clocks—electronic billboards which supposedly show the amount of money owed by the government. Some also attempt to show the money owed per capita or per family. There is a significant level of fluctuation day-to-day, both up and down, so any "clocks" must be continually re-set with proper values.

The most famous debt clock, located in Times Square in New York City, was created by eccentric real estate mogul Seymour Durst. The clock is now owned by his son Douglas Durst. Durst's clock was deactivated in 2000 when the debt began to decrease. However, following large increases, the clock was reactivated a few years later, though had to be moved to make way for One Bryant Park. (Interestingly, some "man on the street" interviews showed that some people felt that the sign's deactivation meant that the debt had been eliminated, though it remained at roughly $5 trillion.) According to Durst the National debt is now increasing at such a rate that his clock will be obsolete (for lack of digits) when the debt reaches the $10 trillion mark, expected in the next two years.

There is an online debt clock at: brillig A free debt clock for web sites is available at: zFacts

[edit] Statistics and comparables

U.S. public debt on 30 December 2005 was $8,170 billion (or $8.1 trillion),[37] which is nearly six times the amount of United States currency in circulation (M1 Money Supply), estimated to be $1,372 billion.[38]

U.S. official gold reserves are worth $160 billion, foreign exchange reserves $63 billion and the Strategic Petroleum Reserve $55 billion.

The debt equates to $28,412 per head of the U.S. population, or $58,390 per head of the U.S. working population.[39]

In 2003, $318 billion was spent on interest payments servicing the debt, out of a total tax revenue of $1,952 billion.[40]

Total U.S. household debt, including mortgage loan and consumer debt, was $11,400 billion in 2005. By comparison, total U.S. household assets, including real estate, equipment, and financial instruments such as mutual funds, was $62,500 billion in 2005.[41]

Total third world debt was estimated to be $1,300 billion in 1990.[42]

The U.S. balance of trade deficit in goods and services was $725.8 billion in 2005.[43]

The global market capitalization for all stock markets was $43,600 billion (or $43.6 trillion) in March 2006.

[edit] References

Bonner, William; Wiggin, Addison (2006). Empire of Debt: the Rise of an Epic Financial Crisis. Wiley. ISBN 047178253X. Argues that America is a world empire that uses credit in lieu of tribute and that history shows this to be unsustainable.
Cavanaugh, Frances X. (1996). The Truth About the National Debt: Five Myths and One Reality. ISBN 087584734X. Argues that the US is in good economic condition and that talk of the consequences of its debt is unduly alarmist.
Hargreaves, Eric L. (1966). The National Debt.
Macdonald, James (2006). A Free Nation Deep in Debt: The Financial Roots of Democracy. Princeton University Press. ISBN 0-691-12632-1. Argues that democracies eventually defeat autocracies because "countries with representative institutions are able to borrow more cheaply than those with autocratic governments" (p. 4). Bond markets also strengthen democracies internally by giving citizens some of the proverbial power of the purse and by aligning their interests with those of their governments.
Rothbard, Murray Newton (1994). The Case Against the Fed. ISBN 094546617X. Describes the process of debt monetization by a nation's central bank and it's unfortunate consequences on society.
Taylor, George Rogers (ed.) (1950). Hamilton and the National Debt.