Who's afraid of the debt? Everyone except Wall Street
By Andrew Harrer,, Bloomberg News
Pedestrians watch the National Debt Clock in New York on April 19, 2011.
If Congress doesn't raise the debt ceiling by August 2, the United States could default on its debt for the first time in history, according to the Treasury.
The debate about raising the debt limit — which has been increased nearly 100 times including its most recent jump in February — has been exceptionally shrill.
Lost in the debate have been several key facts. The U.S. debt, measured as a percentage of gross domestic product, isn't particularly out of line with most developed nations. The bond market, which should be most worried about the U.S. debt burden, doesn't seem concerned at all about the U.S. debt load.
Congress, which authorized the government's spending, shouldn't be the least bit surprised that the nation has reached its debt limit. But the biggest myth about the debt is that defaulting wouldn't be a problem. It would.
Shocked! Shocked!
Congress should be the last people surprised by hitting the debt ceiling. They passed the authorization to bust through it.
The debt ceiling statute was passed in 1917, and has been routinely raised by Democratic and Republican congresses. Because spending decisions reside with Congress, the debt limit has sometimes been deemed to increase automatically when Congress authorizes spending over the limit.
The nation officially hit the $14.3 trillion ceiling on May 16, but the Treasury, using various accounting tactics, has been able to keep government operating normally. Treasury Secretary Tim Geithner says his department will run out of tricks on Aug. 2, at which point the U.S. could default on its debts.
Congress, of course, was well aware of the debt ceiling when it passed its spending authorization on April 15, which legally mandated a 2011 deficit of about $1.7 trillion. (The federal fiscal year ends Sept. 30.) This hasn't stopped members of Congress from lamenting the feckless spending habits of Congress.
"For decades, Washington has blindly increased the debt limit while doing little to stop spending money that it doesn't have, a dangerous pattern that must end," Rep. Eric Cantor, R-Va., said on April 18. The continuing resolution to fund the government through the end of the fiscal year passed the House of Representatives on April 14 with a vote of 260 for the bill, 167 against, and six not voting. Cantor voted for the bill.
Voting against raising the debt ceiling hasn't been limited to prominent Republicans: Then-senator Barack Obama voted against raising the debt ceiling in 2006, when George W. Bush called for spending that would exceed the limit. Obama has since called that vote "a mistake."
How much?
The U.S. debt is vast, by all accounts. But the country is by no means broke.
The discussion about the deficit is intimidating because the numbers are so large. A billion seconds ago, Jimmy Carter was president, Pete Rose was playing for the Cincinnati Reds, and John Paul II became pope. A trillion seconds ago, wooly mammoths were roaming the earth and man was just venturing out of the trees. A trillion seconds is about 32,000 years, vs. 32 years for a billion seconds.
The U.S. debt has two components: public debt and intragovernmental holdings.
The $9.7 trillion public debt is what the U.S. has borrowed through Treasury securities — Treasury bills, notes and bonds.
The remaining $4.6 trillion is intragovernmental debt, primarily, the government securities held by the trust funds for Social Security and Medicare. The $4.6 trillion is largely an accounting fiction: The special government bonds used for the trust funds would be counted as identical assets and liabilities on a standard balance sheet. Both Medicare and Medicaid are essentially pay-as-you-go operations funded by payroll taxes.
Economists take the $9.7 trillion public debt more seriously than intragovernmental holdings. Congress can authorize cuts in Social Security and Medicare, but it can't renegotiate the terms of outstanding Treasury securities without defaulting.
While $9.7 trillion is still an enormous number, what makes a debt onerous is the borrower's ability to pay. By that measure, the U.S. is nowhere near a debt crisis. Last year, the public debt was about 58% of U.S. gross domestic product. The United Kingdom's was 79% of GDP, and Greece's was nearly 124%.
Even if Congress does nothing to trim spending this year — which is unlikely — government expenditures will fall next year as the federal stimulus program ends and people start to lose unemployment benefits, says Mark Zandi, economist for Moody's Analytics. And tax revenues will rise as the economy expands.
What crisis?
The biggest judge of the nation's debt problems is the bond market. Bond traders are lenders, and they're interested two things: collecting their interest payments, and getting their money back when the bond matures. Any hint of default sends interest rates soaring, just as your credit card rate would rise if you suddenly showed signs of financial distress.
A recent example: When bond investors began to suspect that Greece would be unable to pay its debt, investors drove up the yield on Greek government bonds. The Greek 10-year government bond now yields about 16.5%, vs. 2.9% for German 10-year government bonds.
Are bond investors worried about U.S. debt? Apparently not. The U.S. 10-year note yields 3.17%. Half the U.S. debt is due in about five years, according to the Treasury. A five-year T-note yields 1.5% — less than the current rate of inflation. Bond investors are not only not worried about default, they're not worried about losing the buying power of their money.
BlackRock, the largest publicly traded money manager, ranks the U.S. 15th-lowest among 44 countries for sovereign risk. The index includes the country's overall debt structure and willingness to pay. Top two countries: Norway and Sweden, which also have some of the most generous social programs. Worst: Portugal and Greece.
Investors trust the U.S. Treasury because it has never defaulted, and because the United States has vast resources at its command. The nation's gold reserves, for example, are worth nearly half a trillion dollars at the current price of gold. (Dumping that much gold would, of course, depress the price.) U.S. tax rates are low, compared with other developed nations. The maximum U.S. income tax rate is 35%, and government revenues are about 30% of GDP — relatively low, according to BlackRock. In contrast, the maximum German income tax is 45%; wealthier Germans pay an additional 5.5% surtax.
Most of the U.S. debt is held by U.S. investors: individuals, banks and insurance companies. The largest foreign holder, China, owns about $1.1 trillion of U.S. Treasury securities, or about 11% of public debt.
A catastrophe
Some lawmakers have been floating the notion that hitting the debt ceiling doesn't have to mean default to bondholders. Sen. Pat Toomey, R-Pa., has raised the idea of requiring the Treasury to pay bondholders before anyone else. That would avoid a technical default and require massive budget cuts at the same time.
It's hard to argue, however, that bondholders won't be spooked by the government furloughing workers, shutting down parks or cutting services. If the government made its debt payments and paid Social Security and Medicaid, there would be precious little to pay for defense contractors, federal salaries and other normal functions of the government.
"The hope that we can breach the debt ceiling and nothing bad will happen is just plain wrong," says Zandi. Bonds wouldn't be the only investment affected: Stocks would likely crater, too, on fears of soaring unemployment and higher interest rates. Standard & Poor's said Tuesday that it would slash the U.S. top credit rating slashed to "selective default" if it misses a debt payment.
Nothing quick or easy
While the debt isn't a crisis now, sooner or later the U.S. must take steps to reduce its chronic deficits. And it won't be easy, especially in a weak economy. Cutting jobs and raising taxes both harm the economy.
Paying the debt off entirely would require about $47,000 from each person in the U.S., or $1,572 a year if spread out over 30 years. (The Treasury takes donations, if you're especially concerned about the debt: So far this year, the government has accepted $1.8 million in gifts. Last year, it received $2.8 million.)
The best hope for the government is to to keep debt from building up by reducing or eliminating annual deficits. Eventually, modest declines in debt, coupled with economic growth, would make the nation's debt-to-GDP ratio smaller. This was the approach taken by the U.S. after World War II, when the debt-to-GDP ratio was even larger. The Greatest Generation had higher taxes (a maximum 93%) and smaller government — no Environmental Protection Agency and no Energy Department, among others.
Several countries have greatly improved their debt-to-GDP ratio by a mixture of tax increases and spending cuts. Sweden's gross debt-to-GDP ratio has fallen to 39.6% from 50.4% in 2005, according to the Organisation for Economic Co-operation and Development. The country cut spending and instituted reforms to boost the economy. The fact that it had a surplus heading into the downturn — and a tiny military budget — didn't hurt, either.
But what's required is a national discussion on how best to grapple with the debt — and the perception that voters want politicians to do so. Zandi points to Canada, which has taken big steps towards reducing its debt. "Canadians couldn't find the will to make changes until the electorate got the perception that changes were needed," he says. "Public attitudes swung to 'If you don't cut benefits and raise taxes, we won't vote for you.'"
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