This summer has been one of the hottest on record in Washington, D.C., but unlike past summers, Uncle Sam is more responsible than Mother Nature for the unbearable heat in the Capitol City. The public debt has taken center stage over the last two months as leaders in Washington feverishly debate competing plans to raise the national debt ceiling before the country runs out of cash on August 2. The fact that America has never actually defaulted on its public debt is worth noting. Every major media outlet in America is covering the runaway train that could destroy the fragile economic recovery, so terms such as “deficits, debt ceiling, and default” are routinely being tossed around on cable news programs. For most Americans, the debate over the summer is their first time hearing these terms, and they can barely digest how we even reached this point in our country. I have been receiving a flood of emails, phone calls, and questions about the national debt and any potential consequences that Americans could suffer in the event that our elected officials cannot agree to a bi-partisan solution.
The U.S. Treasury currently has the ability to borrow $14.29 trillion to fund a variety of America’s obligations and commitments, but the country is on the path to surpass that number August 2. Technically the country defaulted in May, but Secretary Geithner has been deploying creative accounting methods to pay bills since then. Increasing the debt ceiling would not alter or create new obligations for the country; the act simply permits the U.S. Treasury to fund those obligations that Congress has already committed to appropriating. However, the American people would like to know how our country accrued so much public debt and who actually holds those bonds.
The fact of the matter is that America has always been in debt. Before the first session of the U.S. Congress came to a close, the public debt stood at more than $75 million, and since that time it has been paid off only once in American history. In 1835, President Andrew Jackson paid off the entire national debt, when he effectively shut down the Second Bank of the United States. Subsequently, the actions that Jackson took would cause the Panic of 1837, and a severely deep depression until 1844.
The U.S. Treasury piles up national debt for a variety of reasons, but the one reason that has the limelight in today’s debate – overspending has led to annual budget deficits. Those never-ending deficits lead to massive public debt and a real overhang in our domestic economy. Mr. Obama has become the “poster boy” for conservative deficit hawks. However, history reveals that overspending is not exclusive to Democrats or Republicans. Between 1960 and 2008, government spending as a share of the economy has bounced around within a fairly narrow range of between 17.7% and 21.8%, and we increased the national debt ceiling 78 times. Ronald Reagan started his term with total debt outstanding of $930 million and increased total debt to $2.7 trillion. Bush 41 started his term with outstanding debt of $2.7 trillion and increased the total debt to $4 trillion. Clinton started with total debt of $4 trillion and increased the total debt to $5.6 trillion. Bush 43 started out at $5.6 trillion and pushed the total debt outstanding to $10 trillion.
Currently, government spending hovers around 25% of GDP with the U.S. Treasury collecting tax revenue around 15% of GDP, and the public debt is $14.2 trillion. The “crowding out effect” of $4.2 trillion of borrowing since 2009, when Obama took office, is that investors are buying Treasury bills instead of investing in the next Google, Microsoft, Wal-Mart, or biotech company, which harms new job creation.
The wide gap between government spending and tax revenue is sounding alarms throughout the country. Elected leaders have drawn a line in the sand and some are on the side of dramatic spending cuts to close the gap while others demand more revenue to regain control of the federal budget. Both camps happen to be right on the issue, but they have failed to compromise and develop a plan that will achieve both goals. The U.S. Treasury is collecting the least amount of revenue in 50 years, but it has nothing to do with tax rates being low. As recently as 2007, the current tax structure raised 18.5% of GDP in revenue, which is slightly above the modern historical average. Even in 2008, when the economy contracted, federal tax receipts still came in at 17.5% of GDP. On the other hand, only a third of the current federal budget deficit is related to new domestic spending. Undoubtedly, the deficit problem is invariably connected to rising borrowing costs and the mediocre economic recovery, and truly has less to do with spending and tax receipts.
There is widespread debate about who serves as banker to the United States. The media pundits enjoy making wild claims such as the Japanese and Chinese are our “bankers”, so one day they could arbitrarily destroy America by dumping our bonds or forcing the American people to “work” for them. However, this conventional wisdom does not bear out when you consider some surprising facts. The reality is that, as of last year, China held 9.5 percent of the country’s total outstanding debt. The largest lender to the U.S. Treasury is the American people – we own 42% of the public debt in the form of Treasury bills and bonds held in our pension funds, endowments, 401(K)s, IRAs, mutual funds, etc. Around $4.6 Trillion or a third of the public debt is actually held by the government itself. Almost 18% of the outstanding Treasury bills are currently in the Social Security trust fund.
The real concern is not who is holding our debt, but instead what if investors begin to demand a higher interest rate on those holdings. At present, the average cost of Treasury borrowing is 2.5%, but the average cost over the last two decades was 5.7%. Should we ramp up to the higher number, annual interest payments would be roughly $420 billion higher in 2014, thus further “crowding out” fundamental government programs – education, defense, and entitlements.
The current state of America’s finances is a dire situation and the challenge in Washington to develop a comprehensive solution is critical. The President and Congress must lead on this issue because the consequences of inaction will severely affect all Americans – not just those wearing “blue” or “red”. If the country fails to meet its financial obligations, then the fallout will be far worse than the effects of the 2008 financial crisis when Lehman defaulted. The aftermath from that company blowing up ravaged credit markets, and then proliferated to money markets shocking the entire financial system. States, local municipalities, corporate, and consumer borrowers would all see borrowing costs rise sharply, leading to reductions in spending and investment, which would trigger new job losses on a significant scale.
Default would have prolonged and far-reaching negative consequences on the safe-haven status of U.S. Treasuries and the American dollar. Currently, international investors and sovereign-wealth funds soak up our bonds in public auctions because of the vast liquidity in our debt market and the historical stability of American debt and currency. Pension funds and endowments in the U.S. that are required to hold AAA rated bonds might be forced to unload the public debt if our bonds were to be downgraded due to no increase in the debt ceiling or failure to agree to a plan that places the country on a sustainable path to reduce national deficits and total debt. U.S. commercial banks hold $1.6 Trillion of government debt and they use Treasuries as collateral for short-term borrowing. A downgrade to U.S. government debt could force them to put up larger amounts of collateral, effectively raising their cost of borrowing.
Finally, Secretary Geithner could find it difficult to mail the 80 Million checks scheduled to go out every month to military families, retirees, disabled Americans, and government contractors, when he loses 40% of the money that is typically available to the Treasury to fund government operations.
Uncle Sam must get its house in order before the pending calamity of inaction reaches the kitchen tables of American families. In good faith, we all have elected our leaders to lead, and to place their service to this great country ahead of any selfish ideology or partisan solutions.
