Will America Ever Pay Off Its Debt?

Assuming no unusual economic event occurs during the last 6 months of the federal fiscal year (ending September 30, 2013), American GDP for that period should be in the range of ~ 16.3 trillion. If so, then the United States will end its fiscal year with a debt to GDP (Gross Domestic Product) ratio of 106%. That means for every $1.00 of GDP, the Federal government owes someone one dollar and six cents. About 78% of this debt to GDP ratio will be in the form of public debt: money that has been borrowed from pension funds, foreign banks, insurance companies, individuals, and so on. Buyers receive notes, bonds and other financial instruments that promise to repay the face value of the paper they purchase plus interest. Interest on this paper is projected to have an average year-end rate of 2.36%. Gross interest costs are estimated to be ~ $293 billion. (Note 1)

Gross Federal Debt also includes interagency (intergovernmental) debt.  For the full fiscal year, another 31% of this debt to GDP ratio was in the form of money that has been borrowed from other federal agencies. These securities, issued by the Treasury, include paper issued to government trust funds, revolving funds, special funds, and the Federal Financing Bank. Social Security is the largest Trust fund and holds over 50% of the Treasury’s interagency paper. Other large creditors that own Federal Government debt include the Civil Service Retirement and Disability Fund, the Medicare Trust Fund, and the Military Retirement Trust Fund. Treasury gives these agencies an electronic IOU that acknowledges the existence of the debt. Booked (but not paid) interest costs for the 2013 fiscal year are estimated to be about $179.3 billion.

Public debt should end fiscal 2013 at ~ $12.4 trillion, interagency (intergovernmental) debt is estimated at ~ $4.9 trillion, and total debt is projected to be ~ $17.3 trillion. The 2013 fiscal year federal budget is $3.8 trillion. For fiscal 2013, total accrued or paid gross interest costs are estimated to be about 12.4% of the federal budget, and about 2.9% of GDP.

With the exception of maturing paper, and demands for funds received by Federal agencies, there is no provision in the 2013 budget to repay any prior debt. The total debt outstanding, including accumulated interest, just keeps growing larger each year.

Despite the common belief that China holds an enormous portion of U.S. debt, two-thirds of the treasury’s bankroll currently comes from the Social Security Trust Fund, pensions for public-sector workers, pensions for military personnel and other retirees, and American investors. China, with less than 8 percent of the U.S. government’s paper, is among several nations that invest in treasury securities. As of March 2013, the Federal Reserve was holding $1.79 trillion in U.S. Treasury securities. On a net basis, it increased its holdings of treasury securities by $58.9 billion in calendar 2012. The Federal Reserve is required to send its net profits to the treasury, and was able to pay $88.9 billion in profits to the treasury in 2012.

For the full fiscal year 2013 budget, gross treasury interest costs are projected to be $472 billion. These interest costs are paid in cash, IOUs, and electronic transfers to its creditors. But treasury does not have to raise $472 billion. This amount is offset by funds received from on and off budget funds, as well as other interest and income sources. Projected net debt interest costs, which are included in the federal government’s annual fiscal budget, will be approximately $247.7 billion.

But why, we ask, is all this accumulation of debt so important? To answer this question, let’s go out five years and construct a scenario for 2018. If GDP is $22.1 trillion, and accumulated debt has increased to $24.1 trillion (both reasonable expectations), then America will have a debt to GDP ratio of 109%. About 76% of this debt to GDP ratio will be in the form of public debt. The remaining 33% will be in the form of debt owed to agencies and Trust Funds. Normalized interest costs on America’s federal debt will have increased by 80% to $741.2 billion. If the federal budget is (as proposed) $4.7 trillion, then interest costs will increase to 15.8% of the annual budget. (Note 1)

For those of you who like their data in pictures, I have included a graph of America’s debt from 2000 – 2013. The data comes to us courtesy of the U. S. Bureau of the Public Debt.

It is also useful to visualize the annual gross cost of America’s federal debt for 2013 and 2018.

But there are two problems.

In my opinion, by 2018 Social Security and Medicare (and perhaps some other trust funds) will no longer be net buyers of treasury securities. They are going to want some portion of their money back in order to fund projected retirement benefits.  If so, the treasury interest income statement will look something like this.

According to this scenario, net treasury interest costs will have increased by 124% to $555.8 billion. These increased interest costs will have to be included in the projected federal budget of $4.7 trillion, forcing either a reduction of federal spending or an increase in the budget. America will either have to raise taxes or borrow more money just to pay the interest on the federal debt. Given the conservative estimate of interest costs in our scenario, interest on America’s debt will have almost doubled from 6.5% of the budget in 2013 to 11.8% of the budget in 2018. Without an increase in taxes, that’s $308 B that would have to be cut from federal programs. You should know, however, interest on the public debt could be substantially higher. Here is a graph of the estimates used in our scenario.

This brings us to the second problem. What if we want to pay down the federal debt?  Could we?  What happens if we just try to pay off the debt that will exist at the end of fiscal 2018 over a period of 20 years? Dividing $ 24.1 Trillion by 20 years means we would pay off $ 1.2 T of America’s debt each year.  The federal budget for 2018 would have to be increased by at least 25% to $5.9 trillion, and ~ 30% of the federal budget would be allocated to servicing America’s federal debt. (Note 1)

Could America pay off its debt?  A graph says it all.

It’s not hard to visualize the scope of America’s debt challenge. Unfortunately, the increased debt service, including the payment of principle and interest, would be a politically unacceptable burden on the budget. In addition, all too many people in Washington - for political reasons - do not believe any meaningful debt reduction is necessary. Consider the plausible solutions:

1. Use austerity measures including a reduction of Social Security, Medicare, Medicaid and other health and retirement benefits to hold the line on further indebtedness.
2. Use draconian austerity measures, including a wealth tax on bank accounts, to save the financial system.
3. Increase sales and income taxes.
4. Shift an increasing share of health care costs to the American worker.
5. Shift more federal spending to State government budgets.
6. Increase the rate of inflation by adjusting interest rates.
7. Print money (also inflationary).
8. Default on selected blocks of treasury debt
9. Take a much longer time to pay off the debt
10. Use trade and/or currency measures to enhance domestic economic growth.
11. Increase tax revenues by encouraging the growth of the private sector.
12. All or some of the above.

But most of these solutions are not politically expedient. America has accumulated an excessive load of debt, is stuck with costly interest payments, and has become vulnerable to the availability of capital (including money created by the Federal Reserve). It is also worth noting these debt estimates do not include a massive off balance sheet accumulation of unfunded obligations for which the America people are legally responsible. There is only one rational conclusion: America has been led into a debt trap from which there is no politically expedient escape. Given the size of the debt burden and Washington’s attitude, a full repayment of America’s existing debt obligations is highly unlikely.

America will never “pay off” its load of federal debt.

This raises an interesting question. If there is no attempt to control the amount of debt on America’s balance sheet, at what point does America become a bad credit risk? And what would happen next?

The election of 2016 should be lively. Someone will point out America’s political elite have buried our children in a mountain of unmanageable debt. Someone will point out Washington has demolished the economy. Someone will claim federal policies have made Wall Street rich. Someone will point out our political system isn’t working.

Someone will propose a radical solution.

TCE

Notes:

Note 1: Data gleaned from Federal Reserve, Treasury, GAO and CBO sources. Estimates are based on a risk adjusted analysis of publically available federal data. The objective of this essay is to provide the reader with a simple and concise explanation of America’s budget debt challenges. The debt costs discussed in the essay do NOT include planned (or unplanned) additions to Federal debt obligations, nor do they include unfunded government obligations (health care, Social Security, welfare, pensions, etc.), or State and Local debt. 

Note 2: Other interest rate assumptions would give a range of interest costs from $650 - $900 billion. The Social Security Trust Fund assumes it will get a minimum of 3.5% interest per year on the treasury paper held by the fund. Other agencies have similar expectations. As a reference, here is the theoretical range of interest rates at various debt to GDP ratios.

Note 3: Trust Fund Management Program.

The Secretary of the U.S. Treasury is designated by law as the managing trustee for eighteen of the approximately two hundred thirty Federal Investment Funds. With over $2.5 Trillion in assets, the Treasury-managed Investment Funds are the majority of the largest Trust Funds in the Federal Government. They receive Social Security, Medicare, excise and employment taxes---all collected by Treasury---as well as premiums, fines, penalties and other designated monies collected by the agencies that administer the programs for which these Trust Funds exist. 

The Bureau of the Public Debt is delegated the responsibility for administering these eighteen Funds. For each of these Funds, Public Debt immediately invests all receipts credited to the Fund, and maintains the invested assets in the Trust Fund account until money is needed by the related Federal Program agency to fund program activity, such as Social Security and unemployment benefit payments, as well as highway funding.

When the program agencies determine that monies are needed, Public Debt redeems securities from the Funds' investment balances, and transfers the cash proceeds, including interest earned on the investments, to the program accounts for disbursement by the agency. The Bureau provides monthly and other periodic reporting to each Fund's program agency.

Data for Federal Debt Charts - Fiscal Year 2013 and 2018

 

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American Home Prices: It Is Possible To Be Optimistic

In my 2008 essay on American home prices, I estimated the national average price of a single family home would decline by more than 30% from the high point of the housing boom in 2006 (see Banks: Bleeding Value and Hiding Desperation, March, 2008). In a later essay, my analysis of the real estate market showed that a decline of 38 % was possible. The basic thesis of both estimates was that the “bottom” would not be reached until per square foot purchase prices were in the same range as the per square foot investment value of rental units. Escalating unemployment and under-employment, along with restricted credit availability and a continuation of mortgage defaults, combined to put an almost chronic downward pressure on single family home values. Generally speaking, unemployed people are more likely to be renters, rather than buyers. Before a given real estate market can reach stability, excess real estate inventory that cannot be sold to home owners has to be purchased by investors and converted into rental units. Per square foot home purchase prices have to decline until they achieve a parity with the capitalized per square foot value of local home rental prices, before they (theoretically) become an attractive investment.

As shown by the following graph, parity appears to have been reached. After falling rapidly to an index value of 140 in 2009, price erosion abruptly moderated. Prices then continued a slow motion erosion until a bottom of minus 35 percent was reached in February of 2012.

The question is: Where do home values go from here? Home prices improved in 13 out of 20 cities surveyed in the January 2013 Standard and Poor’s Case-Shiller Home Price Indices report. But as shown in the graph, national average prices have been relatively flat since August of 2012.

There is reason to be optimistic. Banks have finally become interested in being aggressive real estate lenders, and there is plenty of liquidity in America’s financial system. In addition, speculators have removed large numbers of homes from the market by purchasing them as an investment. The Case-Shiller Index actually increased by 8.1 percent from January 2012 to January 2013. Assuming no catastrophic financial or political event occurs in 2013, and assuming employment improves, and assuming average home price change follows past performance, the indices should increase during the first nine months of 2013, and then moderate again into early 2014.

But maybe not.

TCE 

Note: Housing price data is from Standard and Poor’s Case-Shiller Home Price Indices, a 20 city composite index. The S&P/Case-Shiller Home Price Indices measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States. I average the published values by city.

TCE’s No Spin Look at Employment

From The White House Blog 3/8/2013

“While more work remains to be done; today’s employment report provides evidence that the recovery that began in mid-2009 is gaining traction. Today’s report from the Bureau of Labor Statistics (BLS) shows that private sector businesses added 246,000 jobs in February. Total non-farm payroll employment rose by 236,000 jobs last month. The economy has now added private sector jobs every month for three straight years, and a total of 6.35 million jobs have been added over that period.”

Ok. So we expect the White House to hype the numbers with a positive spin. It’s their job. But what are the real employment numbers?

According to the U. S. Department of Labor, Bureau of Labor Statistics (BLS), Current Population Survey, the American economy added 170,000 new jobs from 1/2012 to 2/2013, net of layoffs and separations. These statistics are for all workers 16 years old and over, and are seasonally adjusted.

Since Barack Hussein Obama took office in 2009, net employment has increased by an average of 27,000 jobs per month, and although 170,000 net new jobs in February is a welcome number, the American economy has only created 72,000 net new jobs per month over the last three months. That means the labor force grew by an average net gain of .05% per month over this three month period.

In comparison to the long term trend, the recent employment gains look less reassuring. The great recession has taken a terrible toll on employment, as seen in the following chart. Against historical data, the current trend would appear to be flat – at best.

What can we expect, going forward?  Increased taxes will reduce consumer discretionary spending, the Federal government does not appear to have any credible plan to channel tax dollars into the creation of permanent private sector jobs, full time private sector employment will suffer under the financial load of Obama Care, the political stalemate in Washington threatens to reduce all job creation, price inflation looms on the horizon, and the economy is projected to only grow about 1.5 percent in 2013.

All of these factors promise to act as a drag on total full time employment.

TCE

Note to self: Cancel credit cards prior to death

I know I have responsibilities.

I have to follow the rules.

I must remember to cancel my credit cards before I die.

Here is why…..

A lady died this past January, and WESTPAC bank billed her for their annual service charges on her credit card, and then added late fees and interest on the monthly charge. The balance had been $0.00, now is about $70.00.

 A family member placed a call to the WESTPAC Bank:

Family Member:

'I am calling to tell you that she died in January.'

WESTPAC:

'The account was never closed and the late fees and charges still apply.'

Family Member:

'Maybe, you should turn it over to collections.'

WESTPAC:

'Since it is two months past due, it already has been turned over to the collections agency.'

Family Member:

So, what will they do when they find out she is dead?'

WESTPAC:

'Either report her account to the frauds division or report her to the credit bureau, maybe both!'

Family Member:

'Do you think God will be mad at her?'

WESTPAC:

'Excuse me?'

Family Member:

'Did you just get what I was telling you . . . The part about her being dead?'

WESTPAC:

'Sir, you'll have to speak to my supervisor.'

Supervisor gets on the phone:

Family Member:

'I'm calling to tell you, she died in January.'

WESTPAC:

'The account was never closed and the late fees and charges still apply.'

Family Member:

'You mean you want to collect from her estate?'

WESTPAC:

(Stammer) 'Are you her lawyer?'

Family Member:

'No, I'm her great nephew.'  (Lawyer info given)

WESTPAC:

'Could you fax us a certificate of death?'

Family Member:

'Sure.'   (Fax number is given)

After they get the fax:

WESTPAC:

'Our system just isn't set up for death. I don't know what more I can do to help.'

Family Member:

'Well, if you figure it out, great! If not, you could just keep billing her. I don't think she will care.'

WESTPAC:

'Well, the late fees and charges do still apply.'

Family Member:

'Would you like her new billing address?'

WESTPAC:

'That might help.'

Family Member:
' Rookwood Memorial Cemetery, 1249 Centenary Rd, Sydney; Plot Number 1049.'

WESTPAC:

'Sir, that's a cemetery!'

Family Member:

'Well, what the # # # # do you do with dead people on your planet?

Bureaucratic procedures are usually proposed or written by people who do not have the capacity to understand their impact. 

TCE