The Public Debt: A Menace to Society? - GD Part 4.2

In the wake of the Financial Crisis, the Private Sector struggled to regain its losses, while the US government sought to stimulate recovery with an array of efforts: 
Quantitative Easing, the Stimulus Package, TARP, extending the length of Unemployment Insurance coverage, extending the Bush Tax Cuts and instituting a Payroll Tax holiday, among other tactics.

But since the Great Recession that followed the Financial Crisis also created a reduction in income for the people, it consequently caused a revenue reduction for the government. This has led to massive government spending and growing deficits.

Is the United States going broke? 


Public Debt vs. Private Debt

Let's look at a graph of US Public Debt (AKA the National Debt or the Federal Debt) and Private Debt. The graph is plotted with the most recent data (2012) on the left, with data from each past year heading to the right. Dollar amounts are in billions, and the figures are adjusted for inflation (2011 dollars). The data was compiled from various documents available through the US Treasury Department and the Federal Reserve websites.

2012 figures for each category in the above graph:

Federal Government (US National Debt): $16.022 trillion
Domestic Financial Sectors: $13.855 trillion
State and Local Governments: $3.003 trillion
Non-Financial Business: $12.008 trillion
Households (Individuals): $12.945 trillion

Private Debt totals $38.808 trillion.
The total of all debt in the United States- both Public and Private- is $57.833 trillion.

Debt in the United States is a growing concern- both in the Public Sector and in the Private Sector of the economy. But is it a crisis? This is a big topic, so I'd like to split it up into smaller chunks.

With the “sequester” looming overhead and the constant battle in Washington, D.C. over spending and deficits, there is much talk about the National Debt (or the Federal Debt/Public Debt). This piece will concentrate on what the debt is, how it works, and if it really is a crisis-- or if it's just political grandstanding.

Federal Debt

While the Federal debt is the largest single category of the total debt in the United States, it's important to point out that about one-third of it ($4.85 trillion) is owed between different departments of the government- the Treasury Dept. calls these "Intra-Government Holdings" - of the remaining $11.6 trillion, more than half (about $6.1 trillion) is owed to US citizens and businesses or other domestic private interests who have bought Treasury Bills and US Bonds. The rest ($5.5 trillion) is owed to foreign countries. However, foreign governments owe the US government approximately $0.89 for every $1.00 of debt the US has borrowed from other nations.

So if the whole world were to decide to settle all international debt outstanding, the United States would be paying out about $5.5 trillion to foreign governments, but would be paid back around $4.8 trillion. The difference is then about $700 billion, or roughly the amount that the US spent on the Department of Defense in 2011.


Debt Growth

The growth rate of the debt is very concerning, especially when depicted this way:

When depicted in raw dollar amounts, not adjusted for inflation, the National Debt looks quite daunting.

However, it's not really relevant to depict the National Debt in non-inflation adjusted raw dollar terms. A better way to judge, both for historical context and in terms of the US's ability to pay, would be as a percent of GDP.

Note: this next graph is plotted in the opposite direction.

As you can see, in terms of debt as a percent of GDP, the US was in a similar situation following World War II. 

Read from 1929 (far right) to 2012 (far left), the above graph depicts Federal Debt (the National Debt) relative to the size of the US economy. That big spike on the right-hand side is the result of World War II spending.

Following World War II, the US had a drastically expanded industrial sector and a labor force specifically trained to work in it. The US was uniquely positioned to become the greatest economic power in the world in terms of manufacturing and finance. 

The rest of the industrialized world was more or less in shambles, and the United States was able to swap debt around as it funded the reconstruction of Japan and large swaths of Europe.

The above graph kind of puts a different spin on the Reagan campaign leading up to the 1980 Presidential Election. Reagan criticized Carter for being a "big spender"- increasing the budget deficit and National Debt- which seemed like a big deal since the US was in the middle of a recession. Yet since 1932, the National Debt had been lower as a percent of the GDP only twice before- in 1979 and in 1974. Ironically, Reagan then went on to triple the National Debt in the subsequent eight years.

Today, much of the US's manufacturing has moved overseas and the government's fiscal gains from the economic boom of 1950's-1970's were virtually erased by what is known as the Reagan Buildup. 

While headway in reducing the debt was begun by the government during the late 1990's, the US soon had a series of economic and political crises. 

The 2000's brought them on relentlessly: the Dot-Com Bubble bust, followed by the September 11th Attacks, more than a decade of conflict in Afghanistan and Iraq, the Financial Crisis of 2007, TARP & other subsequent government bailouts, large perennial expenses like the War on Terror, the newly created Department of Homeland Security, and now the Great Recession-- which seems to be dragging on and on despite everyone's best efforts.

From a purely capitalist perspective, the main focus for a recovery for both the economy as a whole and the National Debt (if it really is a problem at all) should be to rebuild the US manufacturing base and to implement policies that encourage banks to lend, employers to hire, and individuals to spend their money. However, the two major capitalist political parties in the US differ significantly in what those specific policies actually are, which is why the US is facing the greatest partisan gridlock in Washington D.C. since the end of World War II.

US Federal Government Budgets

Quickly, so everyone's clear:

Revenue is how much money the government takes in each year from taxes, tariffs, and other payments. 

Expenditures are what the government spends.

The Deficit is roughly the amount a government has to borrow (usually by issuing bonds) to cover expenditures that exceed revenues each year. There are other financial reasons why a government may issue bonds and borrow money, but we're not going to discuss those now.

The National Debt (the Public/Federal Debt) is the running total of how much debt the government has outstanding/unpaid. The only time the US ever fully paid-off its debt was in 1835. It began borrowing again within a year.

The short bars on the graph between 1976 & 1977 correspond to a period known as "TQ," or Transition Quarter- and this represents a time when the beginning of the Federal Fiscal Year was moved from July 1 to October 1.

In the above graph, which is adjusted for inflation (billions of 2011 dollars), the blue bars represent Revenue (how much the government collected in taxes and other sources), the green bars represent expenditure, and the downward-facing yellow bars are the deficit for each year (yellow upward facing bars signify surpluses). 

The moderate yellow streaks on the far right are WWII spending. The huge yellow bars on the left represent deficit spending after the 2007 Financial Collapse. 

It looks pretty bad until you draw the same data as a percent of GDP:

So now we can see that the recent deficit spending, while immense, is not really on par with deficit spending during World War II. As long as the government can get a handle on its revenue/spending balance within a few years, the US will likely recover, as it has a vastly increased ability to pay compared to the post-WWII era debt-to-GDP ratio.

Wage Stagnation & Federal Revenues

The government gets its money primarily from the people. US citizens finance the government through taxes and the purchase of US Bonds and other instruments. Thus, if the people have less money, the government will very likely have reduced revenue as well.

Here is a graph depicting GDP per Household and Median Income from 1967 to 2011:

GDP per Household has nearly doubled, while Median Income has increased only about 19% since 1967.

We can see above that the blue line (GDP per Household) has been increasing at a higher rate than the green line (Median Income) over this period.

This seems to indicate that the total dollar value of goods and services the US produces has increased more rapidly than the earnings workers take home.

The above shows GDP per capita (the blue line) and Federal Budget Revenue (green bars), again running from 1929 on the right, to 2012 on the  left.

There are actually two axes on this graph, since the GDP is actually much larger than the entire Federal Budget, I had to scale these so we can see the direct correlation between GDP and Federal Revenue. 

Let's have a closer look at just the last 35 years:

What exactly is happening? Mainly, since wages haven't increased with inflation and top income tax rates were slashed by both Reagan and George W. Bush, there have been long-term reductions in Federal Revenue, even though there has been an increase in GDP. 

The only point after 1984 in which the correlation between Federal Revenue and GDP returned to normal was between 1998 and 2001, when unemployment was very low and tax rates were moderately higher.

In FY2011, the government instituted a Payroll Tax holiday, reducing rates temporarily from 6.2% to 4.2%. The Payroll Tax accounts for all funds deducted from a wage-earner's paycheck for Social Security, Medicare and Unemployment Insurance. 

This was a great relief for many wage earners who got to take a larger portion of their income home, and was meant to stimulate spending. There is disagreement over whether it had the desired effect or not. The tax holiday expired in 2013.

Together with the Bush Tax Cuts, the Payroll Tax holiday, increased defense spending (since FY2000 the Defense Department's budget nearly tripled) and the Financial Meltdown/Great Recession, the US government has experienced a rapid increase in annual expenditures but a large net reduction in revenue.

In FY2000 expenditures were $2.3 trillion while revenues were $2.6 trillion-- and the budget ran a $300 billion surplus (in 2011 dollars). Expenditures in FY2010 were $3.5 trillion, while revenue had sunk to $2.16 trillion.

The net reduction in revenue by 2010 was over $500 billion while expenditures increased by $1.2 trillion, leaving a $1.4 trillion deficit. The next year, FY2011, was only slightly better:

US Federal Budget expenditures enacted for FY2011 were $3.63 trillion, but revenues totaled only about $2.3 trillion, leaving a deficit of $1.3 trillion.

Seemingly, the key to making the US Federal budget balance without significantly raising taxes is to somehow encourage wages to rise at pace with GDP-- or at least with inflation. That way, the bulk of the population would pay the same rate in taxes but ultimately provide more revenue for the government while reducing government expenditures.

Discretionary Spending amounts to about half of total Federal expenditures each year. FY2013 is expected to run a deficit under $1 trillion, for the first time since the Financial Crisis.

Does China Own the United States?

I hear a lot about China from pundits and fanatics. China does not "own" the US. They have lent the US government around $1.2 trillion- the largest amount of any single foreign government (although Japan is a very close second, at $1.1 trillion), and it would be crippling for the US to have to pay it all back at once, but:

#1- The debt to China is not a significant amount of the total US National Debt to begin with (only about 7%), and;

#2- That's not how it works. China owns a significant amount in US Bonds and Treasury Bills, which must mature to their term. The only thing the US has to worry about is issuing the annual interest on the bonds. They cannot be paid-out on demand. If China was interested in "cashing them in," they could be sold to other nations or investors. 

Sources: 
http://treasurydirect.gov/NP/BPDLogin?application=np
http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt

In the aftermath of World War II the US dollar became the number one global reserve currency. Countries all over the world use the dollar to pay debts to each other, most commodities are priced and traded in dollars internationally, and the value of many foreign currencies are pinned to the US dollar. 

It does not serve the interests of any nation to allow the United States to fail or to otherwise default on its debts. Nobody wants that-- especially not China; we're their biggest customer. If the US were to fall into financial ruin, it would likely ruin the Chinese economy as well.


The Federal Debt: A Menace to Society?


Despite the whining and grandstanding in Washington D.C., the US government is not about to go broke. Is it heading down an unsustainable path? Absolutely. But it's not simply all about spending, it's how the government spends the money, coupled with an insufficient revenue stream; the budget gap needs to be closed. In terms of international finances, however, it's doing alright for now. 

It could be a disaster if the US's credit rating was downgraded (like it was following the Debt Ceiling debacle last year), if the international community lost faith in the dollar, and/or if the US was otherwise forced to borrow at progressively higher and higher interest rates.


Further, and this may seem reckless, but as a last resort the government can always print more money. On the one hand, inflation is bad because it can stagnate wages while raising consumer prices- but on the other hand, if interest rates on government bonds are low enough (and they've been just about as low as they can get for ten years), inflation can outpace the interest on the government's debt, essentially amounting to negative interest.

However, in the case of the most recent Financial Crisis (as with the Great Depression), the issue of concern has been to avoid massive deflation. The US government has responded to this crisis by buying up large quantities of financial assets from banks, which can shore up the banks' short-term position and spur lending while indirectly increasing the money supply without affecting interest rates. See: Quantitative Easing.

Sadly, the US Federal Budget continues to grow, no matter who is president, no matter what party is in office, no matter who is sitting in Congressional seats-- at a rate usually between 3% and 7% per year. Statements claiming otherwise are just political posturing.

In fact, the only year since FY1965 that the US Federal Budget shrank from one year to the next was FY2010, and that was mostly because TARP (read as: an extra $700 billion) appeared on the FY2009 budget.

The United States government's deficit spending is a concern, but it is not yet a crisis. In times of economic turmoil, deficit spending can ease the woes of wage earners and stimulate economic growth by contributing directly to the GDP through contracts to defense companies, providing social insurance benefits that ensure consumers spend money into the economy (even if they're still unemployed), and infrastructure development that includes big payouts to private contractors. 

All of these government actions create a multiplier effect in which the economic output is greater than the total dollar amount of input. Government spending causes growth in the economy (especially through infrastructure projects), which generally causes companies to hire more employees, who earn more money (increasing Federal Revenue) and then spend most of it, increasing economic activity, which prompts businesses to hire more employees... and so forth.

Further down the road, if the US can make some policy changes that further economic development (including encouraging wage growth that at least keeps up with inflation) and if the government can increase its tax revenues without burdening the Middle Class and lower classes, there is a good chance that the current substantial deficit spending and the National Debt in general will not be a problem at all.

Exactly how to do all of these things is another matter-- it is a complicated macro-economic problem, and we'll get back to it later. Meanwhile, here's a great video on the topic of government debt by John Green of the vlogbrothers.

The Global Economic Collapse - GD Part 4.1

The Financial Collapse of 2007-08 affected everyone- globally. It has exposed inherent flaws in our globalized world- our banking and monetary systems are interconnected today to a degree that never existed before. Economists since the 1990s have been talking of "contagion;" financial turmoil in one part of the world can now easily spread throughout the entire global financial system and crush economies, bankrupt entire nations, or merely cause recessions.

The scale of the disaster is not yet known. As of right now, the US seems to believe the emergency has passed, at least if you ask officials publicly-- but high-level officials are still scrambling to fight the spread of the turmoil. That is why Europe's problems are still front-and-center in the news, and partly why it would be disastrous if any country in the Eurozone defaulted on its debt- it would begin a domino effect in Europe which could easily spread to other parts of the world.

Many economists and news sources compare the financial meltdown of 2007-08 to the Great Depression. Indeed, there are many similarities. However, the response has differed on many levels, and the result is that "the biggest economic downturn since the Great Depression" still doesn't quite match the scale of the devastation wrought in those years. Yet, there still is danger on the horizon, and the experience is not quite finished.


Causes of the Collapse

Beginning in the United States and then spreading to the rest of the world due to our globalized finance system, the financial meltdown was a case of reckless investing, fraud, and regulatory neglect. What a lot of Americans don't realize is that it was a direct result of the 1999 removal of vital legislation (the Glass-Steagal Act) that was enacted in the United States following the 1929 Crash that led to the Great Depression. The Glass-Steagal Act of 1933 was designed to prevent the very type of incident that wound up happening in 2008.

In a nutshell, Glass-Steagal prevented commercial banks (banks that make loans and hold your money) from being the same institutions that buy/sell/make investments. This basically kept the banks that hold your money and loans from gambling in the stock market or reinvesting their assets and liabilities in risky financial instruments. Among several other pieces of Depression Era legislation, Federal Deposit Insurance agencies were set up to ensure that the deposits of customers at these banking institutions were protected in the case that their money was somehow lost (due to robbery, physical destruction of bank notes, bank failure, etc.). 

The repeal of these laws led to a dangerous entanglement of financial institutions- commercial banks, investment banks, securities handlers/private investment insurers and hedge funds were hopelessly interrelated with no firewall in place in case of calamity or market failure. Worse yet, in some cases they were insured by both private and federal agencies. 

Even more troubling, in a bid to make big profits even bigger, major banking institutions began leveraging their assets as high as 40:1 and investing in securities, derivatives and hedge funds to distribute the risk. American institutions were the inventors of these practices during the 1990s, but banking instituions in the rest of the world were so impressed with the profits being made, they soon began engaging in these same risky practices. What had been created was an illusion. There was a promise of well-distributed risk, but in reality the risks were mounting higher and higher while infecting every corner of the global financial system.

When the bottom dropped out of the Mortgage-backed Securities market and CDOs, banks and insurers both began to fail at an alarming rate. These institutions had just gone through a rapid merger and consolidation process throughout the 1990s and 2000s, leading to the creation of institutions that were so large their failures were a systemic risk to the economy of the entire world-- not just the US economy.

This 11-minute video explains what happened with the CDOs and Mortgage-backed Securities rather succinctly:

"The Crisis of Credit Visualized" by Jonathan Jarvis

http://www.youtube.com/watch?v=bx_LWm6_6tA

Since the scale of the collapse was so immense, the government of the United States was faced with a rather ludicrous paradox to its capitalist system: we now had to resort to a form of socialism in order to prevent the collapse of capitalism. The banks got bailed out, through several means. 


Flawed Responses

Overtly, TARP (Troubled Assets Relief Program) was administered by the Bush and Obama administrations, followed by several economic stimulus programs at an ever-increasing price tag of over $3 trillion (subsidized, of course, by the American taxpayer). 

Covertly-- mainly to secure confidence in the system-- the Federal Reserve also implemented "secret" loans to some of the largest banking institutions in the world (not just American banks). These loans were delivered as short-term loans at what is known at the Fed as the "discount window" in which interest rates are at or close to zero. 

Page 131 of the GAO's Report. Dollar amounts are in billions.

The main idea behind this was to save these institutions from total collapse while encouraging lending between banks and (hopefully) to consumers in general. The Federal Reserve handed out loans to major banks worldwide (but mainly US & European banks) valuing a total of $16 trillion. It worked- but only halfway. The institutions stayed open, but credit was not freed up. This prevented a total economic collapse, but failed to stop the global Great Recession.

Aside from this arrangement, the Fed also secured a currency-swap with the Central Banks of the EU, the United Kingdom, South Korea, Switzerland, Norway, Sweden, Denmark, Canada, Australia, Brazil, Mexico, Singapore, and Japan, in which the Fed lent $10 trillion USD in exchange for the currencies of these countries (secured at the cost of dollars/unit of currency of the day, with no appreciation or depreciation). 


Total price tag of the Federal Reserve's efforts was $26 trillion USD. Read the GAO's report on the Federal Reserve's Activities during the bailout here: 
http://www.sanders.senate.gov/imo/media/doc/GAO%20Fed%20Investigation.pdf

Page 131 again, with emphasis added. These loans were administered without the knowledge or consent of the US Congress.

This information only came to light due to the first-and-only audit of the US Federal Reserve since its creation. The audit was administered by the Government Accountability Office and only investigated the activity surrounding the financial collapse and emergency relief funds extended to banks during the aftermath. As it turns out, the loans were largely repaid. Only about $1 trillion remained outstanding at the time of the audit. Banks mostly were able to afford this because of two things: they didn't extend credit like they were supposed to, and they levied interest and fee increases on their customers.

So in other words, the people paid for this crisis twice (or three times, depending on how you count): Once in lost assets, once in tax money administered by the government bailouts in all forms, and then once again in fee increases imposed upon banks' customers.

No wonder the economy was in such a shambles! The money at the Federal Reserve is "printed" at our expense; the banks financed their repayment of the debt to the Fed on fees imposed on you & me, and the banks still refused to resume lending. You may remember that at the time during & following the bailout, credit card companies began charging ridiculous interest rates on new and at-risk customers-- rates far beyond what used to be called "usury" -- up to 75%.

Meanwhile, homeowners- even ones in good standing- began to experience the loss of their biggest investment. House prices fell so rapidly that many homeowners suddenly realized they were paying on mortgages that far outmatched the present value of their homes (we call these "underwater mortgages").

Foreclosure rates not seen since the Great Depression ensued, and unemployment skyrocketed (While it's important to be sure the scale of today's problems aren't understated, it's worthwhile noting that the home foreclosure and unemployment rates never really came close to the rates of foreclosures and unemployment during the Great Depression). We had entered the Great Recession.

Socialism For the Rich, Capitalism for Everyone Else

What followed these events led to the eruption of populist uprisings like Occupy Wall Street (OWS). The average American was outraged that, not only had the government bailed-out these irresponsible banks, but they refused to institute effective regulation of these institutions. The OWS battle cry became, "Banks got bailed out; we got sold out!" the core concepts of capitalism seemed to be torn asunder. Bernie Sanders (I-Vermont) said of the bailouts, "This is a clear case of socialism for the rich and rugged, you're-on-your-own individualism for everyone else."

For the banks, this institutionalized a concept called "moral hazard" in which the banks know they are too big to fail, and that if they are on their way down, the government must step in to save them, or risk the collapse of the entire system and contagion to the rest of the Global Economy, thus incentivizing systemic risk if the potential short-term gains are high.

Countries in the European Union are still reeling from this disaster, and while it cannot be said that it was the only cause of their woes, the financial collapse was the catalyst that caused countries like Spain, Greece, Ireland and Italy to slip toward bankruptcy.

The Federal Reserve Bank continues to treat the problem by "Quantitative Easing" (inflating the money supply domestically) and by sending trillions of dollars to the EU, to prop up their Central Bank. Normally, this would cause inflation rates to soar, but the problem we could be facing in absence of this tactic would be massive deflation.

To be clear: there are many details and inner workings of the real economy that complicate and exacerbate the situation of frozen credit markets; large corporations often borrow money to cover R&D, new acquisitions and, yes, even employee payroll. Thus, the reason for rampant unemployment: if companies can't get easy credit, they can't expand as easily, nor can they afford to hire American workers.

My opinion is that the bailouts, while repugnant to the core principles of capitalism, were utterly necessary to prevent a second Great Depression. Where the US government's response failed was at three points:

1. The bailouts weren't big enough to solve the credit crisis, and banks remained leery of loaning money, even to each other.

2. U.S. banking institutions should have been dismantled to pre-1999 sizes, separating commercial banks from investment banks, and should have been led through government-managed bankruptcy proceedings as a condition of accepting federal funds.

3. Homeowners whose mortgages were threatened by falling home prices and frozen credit should have had their debts forgiven by failing banks. At least then there would have been an equitable extension of "socialism" for all and a suitable punishment for the banks and financial institutions that caused the crisis, while freeing up what little liquidity there still was in the private economy.

The real betrayal happened in more recent days, however. While the US is still facing high unemployment, the stock market has regained almost all of its losses, the GDP of the US is higher than ever (albeit at a slightly reduced rate of growth) and corporate profits after taxes are at record highs. While many common folk seemed to (bafflingly) blame the government for this predicament, the onus falls squarely on bankers and the directors of large corporations.

Yet, the "solutions" proposed by this group of the richest people in the world are the same exact reckless philosophies that led to the crisis in the first place. They are demanding reduced regulations in banking and lower corporate, individual and Capital Gains taxes.

The question at the root of all of this is whether or not to support what some economists call "Market Fundamentalism" in which a free, unregulated market allegedly functions perfectly and makes "natural" corrections, or to return to what is known as Keynesian Economics, in which the government allows a certain amount of economic freedom in a pre-determined market, while controlling liquidity and interest rates through a government-supervised Central Bank. 

I personally think the concept of "Market Fundamentalism" (an extreme view of neo-liberal economic policies) is more akin to "Economic Anarchy." Think of it on a social scale: if there were no laws, there would be no police and no judicial system. Would that eliminate crime? Would society "correct itself" and regulate itself? I'd hate to see the brutal Darwinist world that would emerge from such a policy, just as I'd like to avoid the emergence of a Darwinist economic anarchy of a "truly free" market as these fundamentalists envision. What would inevitably emerge would be giant corporations and megalithic monopolies that would steamroll over small business and crush workers. We may as well submit to feudalism.

We've already seen the consequences of loosening regulations. I don't need any more proof. Do you? 

For additional information on this topic, I highly recommend "Freefall: America, Free Markets, and the Sinking of the World Economy" by the Nobel Prize-winning Economist Joseph Stiglitz.

You can find an excellent film called "Inside Job" on this topic at Netflix.com or at your local video rental location.

For additional historical perspective on this topic and how it relates to Globalism and Free Trade Agreements, please watch this PBS series, "Commanding Heights: The Battle for the World Economy."