The insanity of US government debt

A single chart in a recent Bloomberg article sums up just how insane our government's handling of debt and expenditure has become.  The chart is from Drew Matus, the Deputy Chief US Economist and Managing Director at UBS Investment Bank in New York.  He comments:  "The Fed is set to absorb almost all of the supply of U.S. Treasury debt this year, just as they did last year.  Even a modest reduction in the rate of buying could have a disruptive impact on interest rates and the economy."

That chart is absolutely mind-boggling.  It shows clearly how little US debt (i.e. Treasury bonds, issued to pay for US government expenditure that isn't funded by tax revenue) is currently being purchased by independent investors or other countries.  They've largely stopped buying Treasuries, because they can see the fiscal writing on the wall.  To take up the slack left by their departure from the market, the Federal Reserve is simply 'printing money' (or, in reality, tapping ones and zeroes into a computer keyboard to artificially create money, with nothing of any value underlying or backing this fiat currency) and using it to buy these bonds.  It's a gigantic paper chase.  The Treasury decides it needs an extra (say) quarter-trillion dollars, so it offers that value of bonds for sale.  No-one buys them, so the Fed steps up to the plate and prints another quarter-trillion dollars, which it uses to buy those bonds.  The Treasury then spends that 'income' until it's all gone, when it issues more bonds, and the cycle repeats itself.

This is precisely and exactly the same as if I were running my household budget on fantasy, rather than income.  I look at my anticipated bills for the year, and find that they total (say) $50,000;  but my income for the year, after taxes, is only going to be $30,000.  I can't get any bank to extend credit to me;  so I say to my wife, "Darling, write me a check for $20,000 on our joint account, please, payable to me."  She does so;  I deposit it right back into our joint account;  and the bank honors it as a deposit, increasing our balance by that amount.  In reality, of course, that would never happen - instead, the bank would freeze my account and begin proceedings to charge me with fraud!  Nevertheless, that's exactly what our government is doing, day in and day out.  That chart proves it.

This government debt is what some liberal economists (e.g. Paul Krugman) are telling us 'doesn't matter'.  I think that's insane!  So do many other more conservative economists (e.g. Steven Rattner), and the debate over its true significance is raging unabated.  However, I think that when we put it in terms of a household's spending, rather than a nation's, it tends to put it into proper perspective.  Our national household has been - and is still - using money it doesn't have, and is making up out of thin air, to fund its excessive expenditures.

Every year, the nation's accumulated deficit grows.  When will it be too much?  Was it too much at $10 trillion?  We reached that figure in 2009.  It's currently at over $16 trillion - 106% of our GDP.  In other words, our federal government now owes more money than the entire US economy makes in a year - and that's just for its routine annual expenditure, ignoring future liabilities for programs like Social Security or Medicare, which total many tens of trillions of dollars more.  Within a matter of a few years - certainly by the end of President Obama's second term, unless he changes his policies or the Congress and the Senate refuse to fund them - the deficit will exceed $20 trillion.  When and where do we stop?

As Gonzalo Lira commented a couple of months ago:

... why do people like me freak out about the amount of debt that the Federal government is floating?  Simple: Because either the fiscal overindebtedness causes interest rates to spike, thereby crashing the country’s economy and bankrupting its government; or it leads to runaway inflation that spirals out of control and into hyperinflation, thereby crashing the country’s economy and bankrupting its government. A garden of forking paths, maybe, but it all leads to the same crummy destination.

Go read his whole article.  It's the best analysis of this mess I've seen yet.

The only reason the US government can currently expend the amounts it's spending is that the Fed obligingly prints the money it needs to do so.  If the Fed stops doing that, US government expenditure - and all the programs funded by it - will have to be cut back very sharply.  If (currently extremely low) interest rates rise, that will have the same effect, as more and more US government expenditure will have to be diverted to pay increased interest costs on outstanding Treasury bonds and other short-term debt.  Any major international financial disruption will do the same thing.  (For example, China holds something like a trillion dollars worth of US debt.  If it becomes angry with this country for any reason - our support for Japan over the Senkaku Islands dispute, for example - it could simply dump half a trillion dollars' worth of that debt on the international market.  This would instantly flood the market with US treasury bonds, taking away our ability to sell more, and would drive the prices of those bonds into the cellar.  This would devastate global financial markets, as many nations rely on US treasuries as important elements of their financial reserves - which would thus be catastrophically devalued.  Sure, it'd cost China half a trillion dollars - but a war would cost several trillion.  A simple financial maneuver that would cripple the US economy overnight might seem cheap at the price, in comparison!)

The present situation is, quite simply, insane;  and those who urge the continuation of these policies are illustrating Einstein's genius when he defined insanity as "doing the same thing over and over again and expecting different results".  We've been doing the same thing for decades, and it's got us into our present mess.  Continuing to do the same thing will do nothing but make it worse . . . but our politicians don't have the courage to do what's needed, and cut back our entitlement expenditure.  It's a colossal failure of leadership, and by electing and re-electing such leaders, we're all going to pay for their failure, sooner or later.

Peter