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Winnipeg Free Press - PRINT EDITION

No nuts for winter, U.S. starved by debt

Government in the red by more than $15T

By: Satyajit Das

Posted: 01/14/2012 1:00 AM | Comments: 0 (including replies)

Ralph Waldo Emerson wrote: "The world owes more than the world can pay." The United States certainly owes more than it can repay.

U.S. government debt totals over $15 trillion. The U.S. Treasury estimates this debt will rise to around $20 trillion by 2015, over 100 per cent of America's gross domestic product. Even these dire forecasts rely on extremely robust assumptions about U.S. growth of around five to 5.5 per cent a year. Lower growth will translate into higher debt levels.

There are other commitments not explicitly included in the debt figures reported by the government. Since July 2008, the U.S. government has supported Freddie Mac and Fannie Mae (known as government-sponsored enterprises) to the tune of over $5 trillion. The debt statistics do not include a number of unfunded obligations -- the current value of mandatory payments for programs such as Medicare ($23 trillion), Medicaid ($35 trillion) and Social Security ($8 trillion). In addition to federal debt, U.S. state governments and municipalities have debt of around $3 trillion.

U.S. public finances deteriorated significantly over recent years. Pacific Investment Management Co.'s Bill Gross observed: "What a good country or a good squirrel should be doing is stashing away nuts for the winter. The United States is not only not saving nuts, it's eating the ones left over from the last winter."

In 2001, the Congressional Budget Office (CBO) forecast average annual surpluses of approximately $850 billion from 2009-2012. With the budget balanced and forecasts of ever-larger annual surpluses indefinitely, the CBO estimated Washington would have enough money by the end of the decade to pay off everything it owed.

The surpluses never emerged.

Instead, the U.S. government has run large budget deficits of approximately $1 trillion a year in recent years. The major drivers of this turnaround include: tax revenue declines due to recessions (28 per cent); tax cuts (21 per cent); increased defence spending (15 per cent); non-defence spending (12 per cent) higher interest costs (11 per cent); and the 2009 stimulus package (six per cent). German Finance Minister Wolfgang Schäuble told the Wall Street Journal on Nov. 8, 2010, that: "The U.S.A. lived off credit for too long, inflated its financial sector massively and neglected its industrial base."

The U.S. government holds around 40 per cent of the debt through the Federal Reserve ($1.6 trillion), Social Security Trust Fund ($2.7 trillion) and other government trust funds ($1.9 trillion). Individuals, corporations, banks, insurance companies, pension funds, mutual funds and state or local governments hold $3.6 trillion. Foreign investors hold the remainder, including China ($1.2 trillion), Japan ($0.9 trillion) and "other," principally oil exporting nations, Asian central banks or sovereign wealth funds ($2.4 trillion).

Until the global financial crisis, foreign lenders -- especially central banks with large foreign exchange reserves, led by the Chinese -- increased their purchases of U.S. government debt as part of a giant global liquidity scheme.

These reserves arose from dollars received from exports and foreign investment that had to be exchanged into local currency. To avoid increases in the value of the currency that would affect the competitive position of their exporters, the exporting nations invested the reserves in dollar-denominated investment, primarily U.S. Treasury bonds and other high-quality securities. By the middle 2000s, foreign buyers were purchasing around 50 per cent of U.S. government bonds.

During this period, emerging countries such as China fuelled American growth, both supplying cheap goods and providing cheap funding to finance the purchase of these goods. It was a mutually convenient addiction -- China financed customers, creating demand for exports, and America received the money to buy cheap Chinese goods.

After the global financial crisis, foreign purchases have decreased to around 30 per cent of new issuance. Around 70 per cent of U.S. government bonds ($0.9 trillion) have been purchased by the Federal Reserve as part of successive rounds of quantitative easing.

The large stock of U.S. debt and seemingly uncontrollable U.S. budget deficits pose several problems. Is the level of debt sustainable? How is it going to be funded? How can the deficits and debt be brought under control? What happens if the United States finds itself unable to finances its requirements? The answer to these questions will shape the global financial economic landscape for a long time to come.

Satyajit Das is the author of Extreme Money: The Masters of the Universe and the Cult of Risk (2011) and Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives -- Revised Edition (2010), and a consultant to Jory Capital.

Drowning in debt

Today: More than it can repay

Next: Balance of financial terror

Then: The FMD solution

Republished from the Winnipeg Free Press print edition January 14, 2012 B19

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