The Magnitude Of The Mess We’re In
In an excellent article in the Wall Street Journal, George P. Shultz, Michael J. Boskin, John F. Cogan, Allan H. Meltzer and John B. Taylor, reveal the true scale of America’s debt problem. They also make it very clear that if the US doesn’t change course, sooner or later it will find itself at the centre of a Greek-style funding crisis.
The article begins with some staggering facts, such as, “annual spending by the federal government now exceeds the 2007 level by about $1 trillion? With a slow economy, revenues are little changed. The result is an unprecedented string of federal budget deficits, $1.4 trillion in 2009, $1.3 trillion in 2010, $1.3 trillion in 2011, and another $1.2 trillion on the way this year. The four-year increase in borrowing amounts to $55,000 per U.S. household.”
The article goes on to report that during the last fiscal year, around three-quarters of the deficit was financed by the Federal Reserve, something which we have pointed out before.
From the article:
“The Fed now owns one in six dollars of the national debt, the largest percentage of GDP in history, larger than even at the end of World War II.”
“The Fed has effectively replaced the entire interbank money market and large segments of other markets with itself. It determines the interest rate by declaring what it will pay on reserve balances at the Fed without regard for the supply and demand of money. By replacing large decentralized markets with centralized control by a few government officials, the Fed is distorting incentives and interfering with price discovery with unintended economic consequences.”
The article also makes it clear that the Fed’s QE programme if actually a bailout of US banks. “The Fed is paying the banks almost $4 billion a year.”
The problem is about to get much worse. “President Obama’s budget will raise the federal debt-to-GDP ratio to 80.4% in two years, about double its level at the end of 2008, and a larger percentage point increase than Greece from the end of 2008 to the beginning of this year.” The debt will expand from $10.8 trillion to $18.8 trillion in 10 years. “The interest costs alone will reach $743 billion a year, more than we are currently spending on Social Security, Medicare or national defense, even under the benign assumption of no inflationary increase or adverse bond-market reaction. For every one percentage point increase in interest rates above this projection, interest costs rise by more than $100 billion, more than current spending on veterans’ health and the National Institutes of Health combined.”
The article concludes that the problems in the US are “close to being unmanageable now”, but if America doesn’t change course, they will be “completely unmanageable, culminating in an unwelcome explosion and crisis”. It does however offer some solutions.
“The fixes are blindingly obvious. Economic theory, empirical studies and historical experience teach that the solutions are the lowest possible tax rates on the broadest base, sufficient to fund the necessary functions of government on balance over the business cycle; sound monetary policy; trade liberalization; spending control and entitlement reform; and regulatory, litigation and education reform. The need is clear. Why wait for disaster? The future is now.”