The United States will soon confront a major economic problem, perhaps one unparalleled in the nation’s history. It won’t strike tomorrow, next week, or next month, but it is out there, its roots sown by the demographics of the past half-century and a body politic hesitant to tamper with aging institutions of government. When it emerges, like a tsunami, the destructive consequences of amassing unprecedented federal indebtedness will be overwhelming, and though seemingly distant, when it rears its head it will rise suddenly in our consciousness as if coming without warning.
Illustration by Barbara Kelley
While a searing left-right ideological debate pervades the nation’s economic dialogue, the enormity of our hovering dilemma gets short shrift. The lack of clarity in the policy discourse, the inclination by lawmakers to procrastinate on politically difficult decisions, and the propensity to pass blame and kick the can down the road are stunning. But like the tearing down of the Twin Towers, a hurricane devastating the Louisiana coast, or an earthquake striking San Francisco, our looming fiscal problem has no political division. It is not a Democratic or Republican problem. It has no party signature. It is simply an American problem. And as it draws ever closer, the need for political convergence becomes ever more pressing.
The problem is very transparent. Unlike the miasma of derivative markets or the opaque operations of hedge funds, it’s not clouded by the vagaries of our financial institutions. It’s a pretty straightforward dilemma. As our federal budget deficits have grown, the level of debt taken on by the U.S. Treasury has risen precipitously. Some people take solace by looking at other nations, whose debts represent a considerably larger share of their economic output, making our debt seem manageable. But given the sheer magnitude of our problem, this measure may obscure how significant even a moderate increase in the debt would be and the risk it would pose if we stay on our current course.
The challenges in our path are not modest. Starting today and continuing over the next 20 years, the post–World War II baby-boom generation will nearly double the nation’s aged population, and the baby trough that followed (and has lingered since) will slow the growth of the working population. The baby boomers and the major advances in life expectancy for subsequent generations will cause a swelling number of recipients of Medicare, Medicaid, and Social Security, and the expenditures of those programs will soar, programs whose creation and inherent promises largely preceded the birth of those who now or will soon seek their benefits.
Our looming economic tsunami is simply the mountain of debt those promises portend.
The Gravity of the Situation
When someone asks to borrow money—which is what a country is doing when it puts its Treasury’s securities up for sale—the foremost question of the lender is, “If I buy these securities, what risk do I take? Is your government capable of paying me back in the period we have agreed to? Do you have a vibrant enough economy to enable your government to levy enough taxes or otherwise draw on its national resources to pay me off?”
In the growing discourse about the rising amounts of governmental debt worldwide, the common denominator of a country’s creditworthiness is its debt as a percentage of what its economy produces each year. It’s a proxy indicator, a way to gauge which nations are over-extended and which nations have their fiscal house under control. Eyebrows certainly get raised when a nation’s debt-to-economy ratio hits triple digits. A ratio of 100 or 200 percent sets off alarms. Investors get skittish, interest rates in that country rise, and at some point, the prospect of an investor revolt ignites fears of calamity in that nation’s financial markets and, potentially, those around the world.
Exactly how high does it have to go to become a concern? How much debt is too much? In 2011, Zimbabwe’s debt-to-economy ratio (debt-to-GDP, or gross domestic product) was 231 percent; Japan’s was 208 percent; Greece’s, 165 percent; Italy’s, 120 percent; Belgium’s, 100 percent. Greece has certainly caught the world’s attention with the fiscal turmoil it has experienced. With the possibility of default, investors got scared. Unprecedented changes in taxes and spending became necessary. Spain and Italy have also teetered on the brink, as have various other European nations. Britain too, recognizing its potentially precarious position, has undergone major belt tightening.
Can we in the U.S. take comfort because our debt-to-economy ratio was only 68 percent last year? With a lower ratio than that of other highly developed nations, with our Federal Reserve keeping short-term interest rates near zero, and with investors around the world flocking to U.S. Treasury securities as a safe haven, must we really worry? And while some countries for sure are having difficulty, other countries have markedly higher debt-to-economy ratios than we do, and they haven’t collapsed or sent shock waves around the world.
For many economists, the answer is far more complicated than simply observing this ratio. What’s the direction of the ratio and how rapidly is it moving (up or down)? How quickly has a high-ratio country’s economy advanced and what are its future prospects? How significant are the future commitments its government has taken on? And is the country’s political system stable?
The current level of U.S. Treasury debt and the direction it’s headed are not benign. The U.S. may be a large and powerful nation and our debt-to-economy ratio may not be as bad as others, but that’s no reason to be sanguine. Our debt will very likely go higher. The climb in our ratio from 63 percent in 2010 to 68 percent in 2011—seemingly modest—raised our Treasury debt by $1.1 trillion. That single year’s rise was larger than the economies of all but 12 of the 190 nations tracked by the World Bank. It’s equal to the economy of the state of New York. Absent changes that raise federal revenue or constrain spending, our debt-to-economy ratio could rise above 80 percent over the next three years, exceed 100 percent by 2024, and reach an unfathomable 200 percent by the mid-2030s.
Yes, our economy is advanced and diverse and can produce a lot. Today, it generates one-fourth of the goods and services produced worldwide. And our circumstances differ greatly from those of Greece. But when we look to the future, our governmental spending commitments are enormous. As other burgeoning countries such as China, India, South Korea, and Indonesia expand their economies, their net worth relative to ours will likely grow. Their propensity to generate larger growth rates has been demonstrated. As the Far East and South America continue their rapid spurts, how much more prominent will they become on the world’s economic stage? And what happens to our dollar’s strength then? As our Treasury debt continues its unrelenting rise, will the dollar and our securities still be viewed as a safe haven? Is there possibly a saturation point in the future when investors will say, “We’re looking elsewhere”?
Equally important is that nearly half of our total Treasury debt is held in foreign hands, with most of that concentrated among a relatively small group of players. Three-fourths of what is owed abroad is held by China, Japan, the major oil-exporting nations, and four other countries and banking centers; 44 percent of that amount is held by China and Japan alone.
That makes the debt an obvious national-security concern. In early 2010, a shiver ran through the financial markets after China let go of $34 billion of our debt. The Chinese could create turmoil for us by flooding the markets with their dollar holdings, but they would also hurt themselves in the process, and that in itself serves as an impediment for exploitation. But what happens when there are other countries that become increasingly attractive for international trade and development, and our consumer demand for their goods becomes less important?
Risking Our Way of Life
Ultimately, what’s at issue is our future risks: future risk to our economy, our ability to grow, our standard of living, and our national security. Today, we may be in a bubble. The dollar is king, and so are our government’s securities. But where will we be in 10 years? It’s not just the trajectory of our debt, but what causes it: our government’s propensity to spend more than we are willing to tax ourselves. The level of debt the Treasury has issued publicly could rise to more than $11 trillion by the end of this year, but if we count the debt it owes to the Medicare and Social Security trust funds, as well as to other “entitlement” programs—another $5 trillion—our debt-to-economy ratio suddenly rises above 100 percent.
Should we count those other obligations even though they are simply internal debt, IOUs from one arm of the government to another? Yes, because they represent future spending commitments already set in law. Lawmakers have the ability to change that, and they could raise taxes too. As yet, however, their steps have been no more than tepid, with little or no change to the fiscal path those commitments put us on. Moreover, even if we somehow came up with the money to pay off those debts (probably through more borrowing from the public), we still won’t have enough coming in to pay all of the future spending commitments we’ve made through those programs.
According to the most recent projections of the Medicare and Social Security trustees, even if those internal IOUs are paid off, the programs will run down their legal authority to spend in 2024 and 2033, respectively. Taking all that into account, the Congressional Budget Office (CBO) projects that the amount of federal debt held by the public could rise to 157 percent of our annual economic production by 2032 and 200 percent by 2037. In today’s dollars, it would total more than $30 trillion.
It’s inconceivable that we could run up the national debt to that level. If it existed today, it would equal nearly half of what the entire world produces in a single year. Where are we going to find the investors—at home or abroad—who will allow us to generate such debt? It’s one thing when Zimbabwe runs up a debt of 231 percent of its economy. Its annual economic output is only $7 billion. That doesn’t create economic paralysis in world markets. It’s vastly different to think of the U.S. doing so. By year-end, our $11 trillion or more in publicly held debt will account for one-fourth of the $45 trillion in outstanding debt issued by all governments worldwide.
As a nation, we have come to treat borrowing as simply another ready source of revenue, a spigot that we blithely presume will continually supplement what we tax ourselves. But it’s not, and it won’t. It’s a loan that needs repaying, and as such it’s a claim against future taxes—taxes that may someday fall short because the loan and our spending expectations have grown too large. There is no single trip-wire that signals danger. Complacency has a way of perpetuating itself—no pain, no worry.
However, like the precipitous bursting of the tech bubble in 2000, like the air coming out of the housing market in 2008, and like investor panic over the mounting debts of established European nations, inattentiveness and procrastination toward the rising debt of the world’s largest economy will someday catch up with us, likely quick and with little warning. As a policy path, the status quo won’t suffice. There’s no calamity at our front door today, but the warning signs are there.