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The National Interest

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Legislative and media attention is rotating from health care to financial reform. Yet few are talking about the balance sheet of the Federal Government. Those who are interested are floating their usual arguments against social spending. None of this need be the case. Those interested in social programs need to pay attention to and comment on the deficits and debt. Historically they don't. We have seen this story unfold before. The Clinton era reductions in social spending were partially the result of the deficits and debts that developed over previous administrations. Social spending and programs for the poor and middle class were used to balance budgets. The national debt growth of the 1980s and 1990s pale in comparison to today's fiscal problems. The general indebtedness of the US Government is massive and rising quickly. The monies we have spent over the last 10 years were heavily borrowed. Thus, we will have to pay them back, with interest. Future taxation and spending decisions will be pressured by the debt overhang.

Already we are hearing murmurs from bond ratings agencies that the US could lose its AAA rating. What does this mean? Moody's, Standard & Poor's and Fitch make a fine business rating debt. They rate corporate and state debt, as well as structured financial products. The primary purpose of these ratings is to inform investors about how safe bonds are. Ratings serve as guidelines regarding the likelihood of timely and complete repayment. The higher your rating, the more money you are able to borrow and the lower the interest cost. Conversely, the lower your rating, the less money you can borrow, the more you pay in interest and the stricter the penalty structure you will have to accept for non-payment and late payment. Bond rating agencies investigate and monitor the health of borrowers. They issue grades to each bond/security based on the specifics of the contract and the general financial health of the issuer. You have likely heard many stories about the misadventures of these agencies regarding structured consumer debt products. Nonetheless, ratings matter and investors around the world pay attention to ratings and ratings actions.

The US has maintained the highest possible rating, AAA. This signals the strength of the US economy and allows America to borrow vast quantities of money at low interest rates. Most financial models set the risk free rate as the return on the US Treasury. In the last 15 months the US has taken full advantage of this. Our government has sold $2.6 trillion in IOUs since January 2009. We are presently paying around 7% of our budget on interest against our $12.6 trillion national debt. Why so little? Our AAA rating has allowed us to pay an average interest rate of around 3% in 2009. Of the $12.6 trillion national debt $4.5 trillion is held by other US government agencies. Our public debt is presently $7.9 trillion. Since the recession began in December 2007 America's public debt has increased by $2.8 trillion, 54%. This is beginning to make influential parties nervous. The Chinese have been signaling discomfort with the $890 billion in American Securities that they own. The IMF warned last week that rising debt in developing nations is one of the great risks to the world economy.

We are projected to have a $1.3trillion budget deficit in 2010 and have already accumulated a $655billion deficit across the first 5 months of the 2010 fiscal year. Our debt problems are not going away any time soon. The below table makes clear the heavy burden debt is placing on tax revenues already. All the below tax data is from the Congressional Budget Office, CBO. The debt figures are from The Bureau of Public Debt.

Year Interest Expense Tax Revenue Interest Expense % of Tax Revenue
2006 $405,872,109,315 $2,407,300,000,000 17%
2007 $429,977,998,108 $2,568,200,000,000 16.7%
2008 $451,154,049,950 $2,524,300,000,000 17.8%
2009 $383,071,060,815 $2,104,600,000,000 18.2%

The above table makes clear the large and rising cost of our indebtedness. However, these numbers do not fully capture the depth and immediacy of the issue. We have been able to borrow vastly and at low cost. That will be more difficult going forward. We have kept costs low because of our perfect rating and by borrowing short term. Intervention in global markets by the US Federal Reserve and other central banks has driven interest rates very low. We have further lowered our costs by issuing short term Treasuries. The US Government can borrow at lower cost when it borrows for less time. Going forward we face large deficits, pressure on the perceived safety of our debt and the need to issue relatively more long term securities. All of these factors raise the probability that the recent low costs of our massive debt will not last.

We need a serious and policy oriented debate on spending and taxation. This must start with a review of our spending and taxation levels and priorities. Barring another serious global asset market sell-off, there will be pressure on our government as it continues to heavily sell debt. At some point in the future this will be the national economic issue if we don't get serious and make adjustment to our earning and spending. Those caught flat footed in the coming debt policy debates will see chaotic rebalancing efforts precede at their expense. We are already seeing economic pain at the state and local levels responded to with drastic cuts in social spending on schools, public transit, parks and social programs.