Archive
Add Another Trillion
In the midst of the hullabaloo last week over the deal in Washington to end the shutdown of the U.S. government, a little fact missed the attention of most reporters and media outlets. The public debt of the United States is now in excess of $17 trillion.
Technically, the debt ceiling was reached in May and has been stuck at the same level for months. As a result of the continued receipt of federal taxes and other “extraordinary measures” employed by the U.S. Treasury, the nation was able to stave off default until the debt ceiling was raised again. When the debt deal was struck, the official debt of the U.S. increased $329 billion in a day. As a result, the official tally of the debt increased from $16.747 trillion to $17.076 trillion.
Stop and think about that for a moment. While many politicians are touting their accomplishments of deficit reduction and fiscal restraint, the U.S. still overspent by $329 billion in less than 5 months. While it’s an improvement over the recent annual deficits in excess of $1 trillion, the deficit is still projected to be $700-800 billion this year.
While I don’t necessarily agree with their tactics or timing, I do commend those who attempted to draw attention to the continuous deficit spending and rising national debt. Shutting down the government was a drastic step, and in the end, it probably did little to change the current policies or debate. However, it seems painfully obvious that something drastic needs to happen for our national leaders to get in touch with the reality that it’s impossible to borrow trillions of dollars forever.
It wasn’t very many years ago when adding another $1 trillion to the national debt would have been headline news. Sadly, we keep breaking the next trillion-dollar mark so quickly, it barely garners anyone’s attention. Of the $17 trillion we owe, nearly 40% of it has been borrowed within the past five years.
If you share the belief of many politicians, pundits and economists that the continual rise of the debt is not an immediate concern, then you probably won’t pay much attention as the debt continues to increase another $1 trillion in a few months.
If you think the perpetual rise of our debt poses a threat to our long-term security and prosperity, you’re probably frustrated that we reached another trillion-dollar milestone and will probably break the $20 trillion mark in the next couple of years. It can be disconcerting to see the lack of concern over this issue, but don’t give up. Now more than ever, you need to speak up and press for change. It may not happen quickly or easily, but if you don’t speak out, who will?
Breaking the $17 trillion mark may have gotten lost in the noise of the deal to end the shutdown and avoiding possible default by the U.S. government. Whether the lack of coverage was accidental or intentional, this is equally important. The shutdown and debt ceiling were an immediate crisis, but the continuous overspending and borrowing by our government is slowing creating a future calamity, which will make the last predicament seem like a nonevent.
Avoiding the Cliff but what about the Abyss?
Congress and President Obama finally reached an agreement to solve the “fiscal cliff.” The compromise, the American Taxpayer Relief Act of 2012, was reached in the early morning hours of January 1, 2013.
Many of our illustrious leaders in Washington tried to sound reasonable by saying no one got what they wanted but it was the best deal they could reach. Essentially, they were saying you may not be happy, but be satisfied.
It’s a sad day if this was the best they could do. I have two primary contentions with the deal they reached. First… the timing and process of the solution, and secondly, the absence of any meaningful changes in federal spending.
The process was extremely political, and the American electorate should expect more… no demand more… of our leaders. The fiscal cliff was primarily created by two pieces of legislation. In December 2010, Congress temporarily extended the “Bush tax cuts” until December 31, 2012. Thus, they have known for two years tax rates would increase unless they passed legislation to extend or change the rates. The other part of the equation was the spending cut provisions agreed to in August 2011 to settle an impasse on increasing the debt limit. Thus, Congress and President Obama have known for 18-24 months the fiscal cliff was coming but didn’t resolve it until after the deadline passed.
I have many smart and successful clients. It has been exceptionally frustrating and difficult for them to make business and financial decisions without knowing what the future tax rates and rules will be. Even on December 31st, no one knew what the rules would be the next day. In my opinion, it was an absolute lack of leadership and prudence on behalf of both branches of government, both houses of Congress and both political parties.
Although the process was frustrating, the most upsetting part of the compromise was the complete absence of spending cuts. The tax increases are projected to raise over $600 billion of additional revenue over the next 10 years, and all spending cuts are postponed, at least for another two months.
President Obama campaigned on a balanced approach to deficit reduction. How can you consider $620 billion of additional revenue and no spending cuts a balanced approach? Our political leaders have promised the spending cuts will come soon, but that’s what they promised when they passed the law in August 2011. It was easy to promise future cuts, but when it came time to actually implement a spending reduction, they postponed them once again.
Don’t be deceived into thinking the new tax revenues will make any significant dent in our debt or deficit. $620 billion is a lot of money, but it’s over the next 10 years. The U.S. Government is currently overspending by $1.3 trillion each year. The additional revenues will help, but we’ll still rack up an additional $10+ trillion in debt over the next decade, based on current spending. The exclusion of spending cuts in this deal was another missed opportunity. Spending cuts are never easy or popular, but I’ll offer two guarantees; 1) spending cuts will come and 2) the longer we wait, the more painful they will be.
There may have been some political winners from the whole fiscal cliff debacle, but I believe we, the American public, were the real losers. The deal cut may have averted the fiscal cliff, but the absence of any real spending cuts pushes us closer to a financial abyss.
A New Record
On Wednesday, the United States of America established a new record, although it may not be one we want to boast about. As of the close of business on Wednesday, the U.S. total debt exceeded $15 trillion.
This bad news gets worse… don’t expect the debt increase to stop or slow down anytime soon. We’re already two months into the current budget year without an approved budget (that’s a different matter). However, the 2012 Budget proposals put forth so far expect to add at least another $1 trillion to the debt, which is approximately $3 billion per day.
Interestingly enough, there was very little media coverage regarding this matter. There was more coverage about Occupy Wall Street, the Supercommittee and the Penn State scandal than our debt breaking the $15 trillion barrier. After all the acrimony earlier this year about raising the debt ceiling, it might not be considered important news.
Here are a few details about our national debt which might interest you.
- The U.S. population is approximately 310 million people, which means there is approximately $48,000 of debt for every man, woman and child.
- The debt is divided into two broad categories; intragovernmental debt and debt held by the public. The intragovernmental debt is $4.7 trillion and the debt held by the public is $10.3 trillion.
- The intragovernmental debt is essentially money owed to the Social Security system. When politicians refer to the Social Security Trust Fund, this is what they mean. Its debt the government owes itself.
- Even though it may be considered an independent government agency, the U.S. Federal Reserve is now the largest stakeholder of the debt held by the public. The Fed currently holds $1.665 trillion of U.S. Treasury Securities.
- China is the second largest holder of debt, with $1.148 trillion.
- As a result of the Federal Reserve’s quantitative easing, its stake in U.S. debt obligations increased by over $850 billion over the past year.
I may be a bit cynical, but unfortunately I don’t think there is much hope Congress will act to stem the flow of red ink in the near term. They battled a few months ago and agreed the debt will rise to over $16 trillion by the end of 2012, so I don’t expect much to happen on the political front. The lack of media coverage is an indication of the lack of interest by Congress in this dubious milestone.
On the bright side, one thing that’s preventing us from being crushed by our own debt is that nearly one-third of the $15 trillion of Treasuries is effectively being held by the federal government (i.e., Social Security and the Federal Reserve). Thus, our real debt to investors is effectively $10 trillion. Not a good situation, but better than $15 trillion.
At the same time, it’s not a healthy position for the government to hold so much of its own debt. Congress may have played fast and loose with the Social Security funds, but the day has arrived when the Social Security payments exceed the taxes collected. It’s going to put more strain on the budget, and the real cash flow of the federal government, as Social Security starts cashing out its intragovernmental loans.
It’s also not great for the Federal Reserve to continually increase its Treasury holdings. As I and others have previously written, the Federal Reserve essentially printed money to buy up a huge chunk of government debt issued over the past 12 months. Quantitative easing may have some economic benefits, but there are tremendous long-term risks from this strategy.
Americans like to break records, and we just broke another one. Unfortunately, it’s an honor we could have done without. The real question is what are we going to do to stop the hemorrhaging and get our fiscal house in order? We just set a new record, and it’s only a matter of months before we break the $16 trillion mark.
Effects of the Credit Downgrade
Late Friday afternoon, Standard & Poor’s (S&P) announced it was downgrading the credit rating of U.S. Treasury securities from AAA to AA+ and retained its negative outlook. Although S&P previously announced it was considering a downgrade, the announcement was a bombshell dropped at the end of a tumultuous week of economic and political news.
- After weeks of political posturing and rancorous debate, Congress passed the Budget Control Act of 2011, increasing the debt ceiling. President Obama signed the legislation on August 2, thereby avoiding a potential default by the U.S. government.
- After the debt deal was done, Moody’s and Fitch Ratings announced they would retain their AAA rating of U.S. Treasuries but continue to monitor U.S. fiscal health.
- The Dow Jones Industrial Average ended a 9-day losing streak with a blistering 334 point decline; wiping out all of the gains for 2011.
- S&P capped the week by announcing their downgrade.
Since Friday afternoon, politicians, economists, and pundits have been discussing the impact of the downgrade. There has also been a lot of pointing fingers of who is to blame for tarnishing the image of the U.S. It has also left a lot of people wondering about the real implications of a downgrade in the credit rating of the U.S. Government.
Here are a couple of things I think you can expect from the downgrade.
- There is a bruising to the American pride and psyche. Nothing has changed since Friday, but most Americans want to believe we are the best of the best. The downgrade is likely to increase the uncertainty and pessimism of the American consumer.
- Interest rates won’t change immediately. Interest rates are effectively determined by the free markets, not by S&P. A credit ratings agency simply tries to assess the risk of a particular security, but it’s up to the market to decide the interest rate. Don’t expect interest rates to change in the near future, but there could be some upward pressure on rates if investors become more leery about the fiscal stability of the U.S. government.
- The stock markets aren’t going to crash. As anticipated, the markets were battered yesterday and lost about 5% of their value, but it’s not a direct correlation to the S&P ratings change. Remember the Dow took a 334 point hit last week before S&P made its announcement. Furthermore, the 10-year Treasury yield fell from Friday’s rate of 3.558%. This means investors bought more Treasuries; the very securities that are supposedly more risky. The selloff is more attributable to the poor outlook of the global economy and European sovereign debt worries. Investors are seeking stability, so they’re buying up Treasuries and gold.
There is one potential redeeming element which may come from the downgrade, but it’s far from certain. This might serve as a wake-up call for our political leaders to get serious about the fiscal future of our country. As I wrote last week, the debt deal was long on promises and short on spending cuts. In my opinion, a 0.6% cut in spending for 2012 is a pittance in light of overall spending. The rating downgrade could prompt our leaders to get serious about tackling the debt and deficit.
No longer is it just extreme fiscal conservatives who think it unrealistic for the U.S. government to overspend by $1 trillion each year without consequence. Standard & Poor’s is a significant player in the global economy. You may question the timing and motivation of their downgrade, but it should serve as a clarion call of the long-term risks and ramifications of our debt and deficit spending. I can only hope our politicians are listening and have the courage to do something about it.
Details of the Debt Deal
After weeks of political wrangling, Congress and President Obama enacted the Budget Control Act of 2011. The legislation provides for an immediate increase the debt ceiling of $400 billion, averting a potential default by the U.S. government. Avoiding default is probably the one thing most Americans are pleased with in this bill.
The debt deal is long on political rhetoric and short on details. While many of our political leaders are touting the success of this legislation as a significant step towards dealing with the fiscal challenges of our country, there is little discussion of what is actually going to happen. Beyond deferring the most significant spending cuts to a Joint Select Committee (JSC) composed of 12 Congressional leaders, evenly divided by house and party, there are few details of how the actual spending cuts are going to be achieved.
The Congressional Budget Office scored the spending cuts to be $2.1 trillion between 2012 through 2021. Of this amount $917 billion is supposed to be guaranteed in exchange for allowing the Treasury to sell another $900 billion in bonds. The remaining $1.2 trillion is supposed to be determined by the JSC. At this point, no one knows what is going to be cut to achieve any savings.
From what has been released, the bill calls for $21 billion of spending cuts in Fiscal 2012 and $42 in 2013. Not surprisingly, the substantial cuts happen far in the future, which means there is always the chance the cuts won’t happen. For those of us who believe government spending is on an unsustainable path, this is not very encouraging. Here are a couple of things to consider.
President Obama’s 2012 Budget proposal calls for $2.6 trillion in revenue and $3.7 trillion of spending; resulting in a $1.1 trillion deficit. The House passed a budget with $2.5 trillion in revenue and $3.5 trillion of spending; racking up a $1 trillion deficit. According to the debt deal, spending will be trimmed by a measly $22 billion. This is about 0.6% of all federal spending for the coming year.
Talking in trillions and billions can seem rather esoteric, so think in these terms. Assume you make $50,000 this year. If you managed your finances like the federal government, you would spend over $70,000, borrowing the difference. If you cut your spending like Congress and the President have proposed, you would only trim your spending by $420 for the next year. That’s right… just a mere $8 per week, even though you’re overspending by $20,000. Given those parameters, would you say you were serious about changing your spending habits by cutting $8 per week?
Many politicians and commentators are calling this a historic piece of legislation. They refer to it as a down payment on our debt and an important first step. This may be true, but it’s an indication of how difficult it is for Congress to cut federal spending. If they can barely manage to trim $22 billion, how are they going to come anywhere near close to $1 trillion? It would take over $1 trillion of additional cuts and/or revenues to balance the budget, before we can even begin to pay down the debt.
The debt deal further illustrates the Congressional propensity to defer hard decisions. Effectively, it will be a future Congress and potentially a different President, who will have to make the hard decisions to cut spending and balance the budget. Given the history and culture of Congress, it’s no wonder the debt deal is long on politics and promises and short on specifics and spending cuts.
Debt Ceiling Extension – Short or Long-Term
One of the issues in the debt ceiling debate is the size of the increase in borrowing capacity, which effectively determines how long before the government runs out of money again. President Obama and some Congressional leaders have demanded any debt ceiling increase cover the projected federal deficit for at least 18 months, thereby deferring the next debt ceiling vote until after the November 2012 election.
Congress has passed and the President has signed three debt ceiling measures over the past 2 ½ years. Here is the history of the debt ceiling votes since President Obama took office in January 2009.
- February 2009 – debt ceiling increased to $12.1 trillion, lasting 10 months
- December 2009 – debt ceiling increased to $12.4 trillion, lasting 2 months
- February 2010 – debt ceiling increased to $14.3 trillion, lasting 15 months
President Obama’s current insistence for a limit to last 18 months is longer than any of the three extension bills he previously signed. Given the acrimonious nature of the current debate and political wrangling, it’s understandable why he prefers to push any future debate beyond the 2012 election. However, a political preference to avoid a contentious issue does not justify vetoing legislation with a shorter time frame.
Many Republicans are willing to pass a shorter-term measure because they believe the political sentiment on this issue is in their favor. In all fairness, if they believed a short-term measure was detrimental to their political future, they would be pushing for a longer term solution as well.
The supporters of the 18-month measure have argued a short-term increase will continue to negatively impact the economy and jeopardize the U.S. Government’s credit rating. However, neither Moody’s nor Standard & Poor’s have indicated the size of debt increase as a significant factor in assessing the credit rating of U.S. Treasury securities. Both have stated there are two primary factors they are considering; 1) the U.S. not defaulting on any of its payments and 2) a meaningful reduction in future budget deficits. The length of a new debt ceiling has not been mentioned as having any bearing on their assessment.
The markets seem to echo this sentiment. We’re days away from the August 2nd default date, yet there has been no appreciable change in the trading or pricing of U.S. Treasuries.
It appears traders and investors assume Congress will pass some measure to prevent the government from defaulting, even if it’s short term. Although investors prefer Congress to act sooner, they understand the political landscape and realize such issues often result in deals being cut at the last moment, or Congress passes a short-term extension to grant themselves more time to reach a deal.
The 2011 Budget is a good example. Rather than shutting down the government for failing to reach an agreement, Congress passed six continuing resolutions to fund the government from October 1, 2010 through April 8, 2011, before the final budget deal was reached. The shortest continuing resolution was 3 days, keeping the government operating from December 18 – 21, 2010. Although it may be annoying and unnecessary, short-term extensions to keep the government operating have become rather common.
At this point, I think a short-term resolution is probably the most likely bill to pass. As much as the President may want an 18-month limit and some conservatives want no increase in the debt ceiling, neither one of them wants to be the blame for the U.S. government defaulting and the potential economic chaos which could result. Political winds can shift rather quickly, and no one wants to be caught downwind of decision which freezes the markets or dramatically increases interest rates.
If you have read any of my prior articles, you know I strongly believe dramatic long-term changes to our fiscal policies are necessary. At the same time, significant changes in policies or spending should not be hastily passed, and I would much prefer good legislation over expediency.
Everyone may be tired of the debate and just want it to be over, but don’t allow politicians to obscure what they’re doing by waiting until the last minute to present and pass something. Spending cuts and tax increases affect real people. Tough choices need to be made… that’s a given. Let’s just make sure we all have time to understand the choices being made by our elected officials; before they are enacted.
Decoding the Debt Debate
If you’re following the current debate on raising the debt ceiling, you’re probably frustrated. Your angst may be triggered by, the partisan bickering, the lack of great leadership or the uncertainty of what may happen and what it all means.
Politicians from all political persuasions and affiliations have become very adept at obfuscation. Knowing whatever they say or do can and will be used against them in a future election, politicians have become very proficient in deflecting and dodging direct answers. They speak in vague terms and try to boil everything down to a 30 second sound bite.
Politicians and political commentators often use terminology that is confusing and often misleading. You almost need a secret decoder to decipher what they are saying. I don’t all of the secret codes, but I have a few.
As you listen to the debate, the following are a few terms to keep in mind.
- The National Debt – The cumulative amount of money owed by the U.S. government. These are actual bonds held by various investors (including the Chinese government and your friendly bank). The total outstanding debt is approximately $14.5 trillion.
- The Debt Ceiling – The total amount of bonds the U.S. Treasury is authorized to issue. The debt ceiling is currently equal to the National Debt. A law must be passed to increase the debt limit.
- Deficit – This is the amount of money the government is spending in excess of revenues it collects in one fiscal year (October 1 – September 30). The deficit for fiscal 2011 is projected to be $1.4 trillion.
- Credit Rating – Every bond traded on a public market is rated by an independent credit rating agency, which assesses the financial strength of the issuer and the likelihood of default. The lower the rating, the higher the interest rate required. For bonds already issued, a change in credit rating will often influence the price at which the bond is traded on the market.
Aside from these terms bantered about, I believe there are a few important factors you need to pay close attention to in any deal that is reached. These will be the types of issues our political leaders will attempt to obfuscate.
- Time Horizon – The time horizon for the spending cuts and additional revenues will be calculated over the next 10 years. If Congress and the President agree to cut $1 trillion in spending, it won’t all come in fiscal 2012. They may sound like everything is happening this year, but any plan will be adopted over the next decade. Raising the debt ceiling is the only thing to take effect immediately.
- Timing – Look at the timing for when additional revenue is received and spending cuts are enacted. If history repeats itself, the revenues will start to be received soon, and the bulk of the spending cuts will happen in the latter years. In the world of pork barrel politics, elected officials use government spending to buy votes, and the termination of programs will frequently cost votes. Thus, politicians have a real incentive to defer spending cuts to another day.
- Details –It won’t be easy, but do your best to understand the details of the plan. Congress is trying to make major changes to the tax code, Social Security, Medicare and Medicaid, and they’re rushing to get it done in the next few days. I don’t think you want a repeat of Nancy Pelosi’s famous quote, “We have to pass the bill so you can find out what is in it.”
I believe this is a serious issue, and how it is resolved could have far-reaching implications for the future. No one knows what will happen if the government defaults on its debt, since it has never happened. As I previously wrote, I think Congress will and should raise the debt ceiling, but it also needs to curtail government spending. Racking up over $1 trillion of debt each year is just as perilous as defaulting on the current obligations by not raising the debt ceiling.
I also have serious reservations about our leaders’ability and willingness to cut spending. The 2011 budget compromise is a good illustration of this. Although they supposedly agreed to $38 billion in spending cuts, most of it was accounting gimmicks and money that wasn’t going to be spent anyway. One analyst calculated the reduction in spending on specific programs to be less than $1 billion in comparison to fiscal 2010.
As the debate continues forward, follow closely. Here’s why. Last week, President Obama was pushing a plan to cut spending by $3.7 trillion and add $1 trillion of new revenue, for a net decrease of $2.7 trillion over the next decade. Sound like a reasonable compromise? Before deciding, you may want to consider this. When the Administration presented their 2012 budget to Congress, they also provided a 10-year budget estimate. The Administration projected total deficits over the next 10 years to be in excess of $9 trillion. If the current deal cuts it by $2.7 trillion, that still means we’ll add over $6 trillion to the national debt, pushing out total debt close to $21 trillion by the end of the decade. Still think it’s a good deal?
To me this is a good example of why we must watch this closely. Despite the political rancor, everyone in Washington is looking for a deal which will make them look good. Let’s just make sure the American people get as good of a deal as our politicians.
