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Natalie Pace

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10 Things You Need to Know About the $16 Trillion U.S. Debt.

Posted: 09/11/2012 6:22 pm

1. Standard and Poor's Not Likely to Downgrade U.S. (until 2014)
2. Largest Holder of U.S. Debt
3. "Debt" to U.S. = Investment to Others.
4. GDP Growth Is a Large Piece of the Equation
5. U.S. Corporations Are Holding a Lot of Cash
6. Oil Reform
7. Tax Reform
8. Health Reform
9. Baby Boomers Are Retiring ("Entitlement" Reform)
10. Credit Risk in Bonds

And here are the details...

1. Standard and Poor's Not Likely to Downgrade U.S. (until 2014)
Standard and Poor's still has the U.S. on negative outlook, however, in a statement released on June 8, the rating agency reaffirmed their rating, warning that "credit risks, primarily political and fiscal, could build to the point of leading us to lower our 'AA+' long-term rating by 2014."

2. We are the Largest Holder of U.S. Debt, Not China
One third of the debt is held in the U.S. Treasury -- borrowed from the "surpluses" in the trusts of Social Security, unemployment, disability, federal employees, hospital insurance and more (source: The World Fact Book). The Federal Reserve holds $2.6 trillion of our treasuries. As of June 2012, China was the largest foreign holder of U.S. treasuries, with $1.16 trillion (of our "debt"), while Japan held $1.1 trillion in U.S. treasuries (source: Treasury.gov).

3. "Debt" to U.S. = Investment to Others.
While politicians call this "debt," the rest of the world calls it an investment. Most people, both foreign and at home, believe the United States is a great country with a lot of things going for it, particularly when compared to the rest of the world. U.S. treasuries are purchased as part of a diversified investment portfolio. In China, it is one of the few ways to get diversified away from over-reliance on Chinese companies. A few years ago, naysayers warned that the euro would replace the dollar as the world's major currency. No one is saying that now. According to a Treasury Department press release on August 15, 2012, " Foreign residents increased their holdings of long-term U.S. securities in June -- net purchases were $5.5 billion."

4. GDP Growth Is a Large Piece of the Equation
Keeping America at the forefront of innovation in the world is a major priority because when we cannot sell our great products to the rest of the world, we end up buying them. Our largest deficits are to China and OPEC, at $27.4 billion and $8.5 billion in the month of June, respectively (source: Bureau of Economic Analysis). Two of the greatest cost containment strategies the U.S. could employ would be to increase domestic manufacturing and to reduce our reliance on foreign oil. The latter has been achieved by President Obama, with his emphasis on renewable energy, fuel efficiency and ending the war in Iraq. Read my blog, "Demand for Foreign Oil at Lowest Point in 15 Years," for additional information. (Deficits are a subtraction in GDP growth.)

5. U.S. Corporations Are Holding a Lot of Cash
According to Howard Silverblatt, senior index analyst, S&P Dow Jones Indices, there is $1.01 trillion sitting in cash in U.S. corporations. Companies, like Apple and Google, have tens of billions in cash, no debt and employees managing their own, self-directed, retirement plans.

6. Oil Reform
In 2011, the United States spent $421 billion on foreign oil and petroleum products (which was lower than President Bush was spending in his last term as president). As Michael Liebreich, the CEO of Bloomberg New Energy Finance, told me in an interview, "It's very hard to see how you can have an efficient economy when hundreds of billions are leeched out of it and sent overseas. No country can develop with that sort of a drag on its economy." As part of the energy independence strategy, U.S. oil production has increased dramatically over the last three years -- up 13% in 2011, compared to production in 2008 when President George W. Bush was in office (source: U.S. Energy Information Administration). Ending the War in Iraq helped tremendously as well because domestic oil is not used in foreign wars -- the military sources its fuel close to "the theater."

7. Tax Reform
Many economists have acknowledged the problem of very wealthy people paying a lower tax rate than middle-class Americans. (The tax rate on long-term capital gains is 15 percent currently, and the majority of very wealthy people earn most of their money through investments, not through wages. The highest tax rate on wages is 35 percent.) What's the most rational correction to this? According to Nobel Prize-winning economist Dr. Gary Becker, it is a flat tax. In his blog, "Buffett and a Better Tax System," Dr. Becker writes, "From a efficiency perspective, the ideal tax system would replace all income taxes with a flat percentage tax on total consumption of each household, as in a flat inclusive value added tax (VAT). A tax on consumption instead of income has the advantage that it would avoid the double taxation of saving." Of course, with all of the lobbies vying for tax credits, tax exclusions, tax advantages, et al., tax reform of this nature will be difficult to achieve politically.

8. Health Reform
While politicians blather on about Obamacare, the real problem with America is not health insurance, it is health. The U.S. spends over $2.5 trillion each year on health care, which is 16.20 percent of GDP -- the second highest health care spending to GDP in the world. Why do we spend so much on health care? We're too fat. 1/3 of Americans are obese. By comparison, countries that make biking safe and offer public transportation, like China and The Netherlands, have almost no obesity and, thus, far lower health care to GDP ratios, at 4.6 percent and 10.80 percent, respectively. Focusing on physical health translates directly into fiscal health.

9. Baby Boomers Are Retiring ("Entitlement" Reform)
Medicare, Medicaid and Social Security cost U.S. about $1.5 trillion in 2010 (10 percent of GDP). This is expected to rise to 15 percent of GDP by 2025, largely due to Baby Boomers retiring. But that's not the only issue. As Dr. Gary Becker explains in his blog, "The Looming Entitlement Fiscal Burden," police, fireman and government employees enjoy early retirement ages, where the annual pension is determined by the pay during the last two years of employment. This offers an incentive for these staff members to work overtime and push for raises right before retirement. One reform that has been proposed is to have defined contribution individual accounts, rather than defined benefits. Another solution is to raise the age of retirement to 70, since people are living longer.

The proposed reform for Medicare and Medicaid is to raise the deductible and coinsurance. This is not just to cut costs, but to also encourage more mindful medical care. Dr. Gary Becker explains the rationale, writing, "As a result of the low out-of-pocket expenses under the present system, neither patients nor their physicians have strong incentives to make serious benefit-cost calculations of whether expensive treatments are desirable."

10. Credit Risk in Bonds
As we've seen in Europe, credit risk, not interest rate risk, is driving the bond market today. The European Central Bank (like the Federal Reserve) has set interest rates at rock bottom, yet Portugal, Ireland, Italy, Greece and Spain all have to borrow money at much higher interest rates to attract any investors. In the United States, the Federal Reserve also has a policy of rolling over their short-term T-bills into long-term Treasuries, in order to keep the rates down. The risk isn't that the U.S. Treasury bill is going to be worthless. It is that, once the Feds leave it to the world markets to buy our Treasury bills, interest rates will rise and existing low-yield U.S. bonds will go down in value and potentially become illiquid (you'll have to hold them, with the low interest rate, until the end of the term). As the federal debt increases, so does the possibility that the buying potential of your Treasury bill will go down in value, both due to higher interest rates and rising inflation.

 

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