A friend once commented about her downsizing company, “you know things are bad at work when people start stabbing each other in the front.”
As the U.S. deficit has grown, the tone around the debt ceiling has gotten increasingly acerbic. There have been calls to let the U.S. default on its debt, which would undermine the U.S.’ position as the global reserve currency.
The intransigence of the political atmosphere today is best represented by the Tea Party Republicans for whom fiscal discipline is paramount. The recent agreement on the debt ceiling debate that kicked the can to December created the political absurdity of members of Congress voting against $ 15 billion in hurricane relief.
But the debt ceiling debate itself is political farce masked as drama. Congress approves spending bills, and the U.S. Treasury raises the money to pay the bills. When Congress debates the debt ceiling, it is just grandstanding about allowing the Treasury to spend what Congress itself has already approved.
A far bigger issue is the size of the total debt in the U.S. The Federal Reserve Statistical Release of the Financial Accounts of the United States is a quarterly compendium of the flow of money in the U.S. It divides the U.S. economy into five sectors: the Federal Government, State and Local Governments, Households, Businesses and Banks.
The next publication, due the third week of September, will highlight the magnitude of the U.S. debt position.
Federal Government debt now exceeds $ 20 trillion, making it larger than the U.S.’ annual GDP.
A Debt to GDP ratio of over 100% is dangerous because traditionally it is a point from which it is difficult for any country to repay its debts without a sustained period of high inflation that dilutes savers’ wealth.
And this $ 20 trillion figure is only part of the picture; it does not include future liabilities from mandatory spending on medical care and Social Security.
State and local governments have significant unfunded pension liabilities. Depending upon the accounting method used and the assumed rate of return, they are underfunded anywhere from $ 2 trillion to $ 5 trillion.
Households carry debt burdens of up to $ 15 trillion, driven by increases in school, credit card and auto debt. Business debt securities and loans exceed $ 13 trillion, up roughly 50% in a decade’s time.
While the banks are healthier then they were a decade ago, the increases in lending leave the banks exposed.
The policy prescriptions the U.S. took after the housing bubble collapse have exacerbated the debt problem. The Federal Reserve undertook a Quantitative Easing (QE) program, driving interest rates down and printing $ 4.5 trillion in new currency to purchase bank assets.
The hope was that it would inject money into the U.S. economy, fueling spending and achieving a target inflation rate. The actions helped save the banking system and ensured the continued functioning of the U.S. economy, but have had adverse side affects that would make any pharmaceutical company proud.
The Federal government abandoned its financial discipline, regularly running annual trillion dollar deficits with the confidence that low interest rates would protect against runaway interest expense.
At the same time, the low interest rates hurt state and local pension funds that are obligated to invest in fixed income securities, lowering annual returns on pension assets and increasing unfunded liabilities.
The QE did not achieve its desired income of a strong economic recovery, with an increase in wages and inflation in goods and services. Instead, it produced asset price inflation, so that household gains in non-cash risk assets such as real estate, stocks and mutual funds were not met with an equivalent gain in wages, leaving household wealth increasingly at risk in the event of a turn in the market.
Businesses took advantage of the low interest rate environment and increased their borrowing sharply.
The Federal Reserve has signaled its intentions to unwind its QE program, beginning with a rise in interest rates. But conditions have put these sectors in a damned if you do, damned if you don’t trap. An interest rate rise could accelerate the Federal government’s debt death spiral, where rising interest payments lead to higher debt, or it could weaken an already tepid economy and lead to lower tax revenue and a higher debt.
Higher interest rates would help state and local pension funds invest in higher rate new debt, but could simultaneously produce a reversal their investments in equities and real estate.
Similarly for households, an increase in interest rates could cause a retreat in prices of stock and real estate assets. A rise in interest rates becomes dangerous for businesses needing to refinance their debt.
Further, a day of reckoning is encroaching. The Baby Boomer generation is heading into retirement, and as a country we seem to have forgotten that if you want your kids to pay for your retirement, you need to actually make enough of them.
The Congressional Budget Office projects that the Social Security Trust Fund will go bankrupt in 2029, meaning that costs not covered by taxes will hit the federal budget directly.
Many state and local pensions are vastly underfunded, and households will receive less than what they expected when they spent their years working.
Large household debt forces people to pay their debts instead of spend on goods and services, which acts as a constraint on GDP and limits how fast the U.S. can grow its GDP to get out of debt. Businesses have benefitted from one of the longest continuous economic expansions on record, but as in roulette, eventually it lands on red, posing a risk to Businesses’ large debt position.
There are many factors that work in the U.S.’ favor for the continued use of the dollar as the world’s reserve currency. The European Central Bank is still printing money as part of its own QE program, China’s corporate sector is drowning in debt, Japan is in a Fukushima-style demographic meltdown, and the West in the midst of a throw out the bums political circus atmosphere.
But the U.S.’ debt problem is not going away. And just as the estimated nearly $ 300 billion in damages from Harvey and Irma dwarf the $ 15 billion hurricane relief package, increased political polarization and fiscal tradeoffs from the debt problem could dwarf any of the rancor around the debt ceiling debate.
Yeshiah Grabie is an economist, M&A professional and writer living in Los Angeles.
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