Thursday, July 28, 2016

Is America Headed For Bankruptcy?

"Two recent pieces of budget news are a grim reminder of the perilous state of fiscal policy in the United States,” my favorite Keynesian economist, Martin Feldstein, professor of economics at Harvard University, says in a Project Syndicate essay.

President Barack Obama’s Office of Management and Budget announced that the federal government’s deficit this fiscal year will be about $600 billion, up by $162 billion from 2015, an increase of more than 35%. And the annual Long-Term Budget Outlook produced by the Congressional Budget Office predicts that, with no change in fiscal policy, federal government debt will rise from 75% of GDP to 86% a decade from now, and then to a record 141% in 2046, near levels in Italy, Portugal, and Greece, Feldstein pointed out.

And he notes:
The Federal Reserve’s unconventional monetary policy has driven down the cost of the net interest on the federal debt to just 1.4% of GDP, despite the increase in the volume of the debt. But as interest rates normalize and the volume of debt grows, the cost of servicing the interest on the national debt is projected to increase to 5.8% of GDP.
Keep in mind, this is a conservative estimate of how climbing interest rates will relate to GDP. The percentage could be much higher. As Feldstein correctly notes:
With a federal debt of 141% of GDP, that 5.8%-of-GDP interest cost implies an average nominal interest rate of just 4% and, given the CBO’s inflation forecast, a real interest rate of about 2% – similar to historic rates when the debt ratio was less than 40% of GDP. But investors in Treasury bonds might demand a much higher interest rate in exchange for loading up their portfolios with US debt. In that case, the interest cost and the debt would be much greater.

Feldstein says, " While the US government would never explicitly default, it could adopt policies such as deducting income tax on interest payments, which would disadvantage foreign holders and depress the value of the bonds. Moreover, foreign investors might fear that very high debt levels could lead to inflationary monetary policy, which would depreciate the value of the dollar and lower the real value of their bonds."

How bad could things get? Feldstein informs:
Here is an amazing and disturbing implication of the CBO’s forecast. By 2046, the projected outlays for the “mandatory” entitlement programs (Social Security and the major health programs), plus interest on the debt, would absorb more than all of the revenue that the government would collect with current tax rates. A small deficit (1.6% of GDP) would emerge even before spending on defense and other annually appropriated “discretionary” programs.
There is no way to offset the growth of the mandatory programs by slowing the growth of defense and other discretionary outlays. Total defense spending is now just 3.2% of GDP and is expected to decline to 2.6% over the next ten years and to remain at that level for the next 20 years. That would be the lowest defense share of GDP since before World War II. The same reduction is projected for all non-defense discretionary programs, also a record-low share of GDP.
So are Hillary Clinton or Donald Trump proposing anything that would move away from this developing crisis? Feldstein concludes:
Neither of the presidential candidates has indicated either a plan or an inclination to reverse the projected rise in the national debt. But it should be a top priority for whoever moves into the White House next year. Given the need to act quickly to avoid the worst-case scenario, there is no excuse for waiting.

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