America's debt problem

Have you heard the statistic, 40% of the budget expenditure is borrowed? Sometimes described as the government borrowing $0.40 for $1 it spends. If the Tea Party refused to raise the debt ceiling in 2011, the budget would have been immediately cut by 40%. There would have been no debt default, but the U.S. economy would have quickly fallen into a depression. Based on current trends, it is very possible that these cuts are coming anyway. Except instead of reducing spending, the cuts will be made in order to pay for interest on the national debt.

In the chart below I assume a static 3% growth in the budget. Revenues, expenditures and the deficit all grow at 3%. The interest cost number I calculate is based on the total debt, not the public debt. Currently, the government doesn't pay cash interest on the SS Trust fund, it accrues the interest. As the fund is depleted, the difference between the total debt and public debt will converge.

To restate, the model is static. I'm not adding in total interest cost to the debt, I'm only looking at what total interest costs would be assuming the static 3% growth in the debt plus the exhaustion of the SS trust fund. I'm not adjusting the deficit growth for rising interest rates. I assume the debt growth is constant; there is no feedback in the model.

I also assume three interest rates on total debt: the current 2.5%, a higher 3.5%, and a doubling to 5%. These are applied statically to show changes in interest costs starting from 2013, if rates were at this level. For comparison, interest costs averaged 5-6% less than 10 years ago. You can see for yourself at Treasury Direct.

Unless there's a huge unforseen growth spurt in real GDP, the deficit will be relatively constant. If the growth comes through inflation, most spending will automatically adjust, unless there's a decision to cut entitlements. Based on the fiscal cliff battle that increased the deficit, there will be no cuts.

In conclusion, without a positive scenario, the U.S. federal government will become insolvent by the turn of or very early in the next decade. If a negative scenario unfolds, the U.S. could be in crisis before the next presidential election.

A more accurate scenario can be devised, but there a serious constraints. Faster growth will lead to a smaller deficit, but higher interest rates. Stronger employment growth will slow the depletion of the SS trust fund, but stronger employment will push up inflation. Entitlements are growing faster than the economy, and Obamacare benefits will hit in 2014, putting pressure on expenditures to increase faster than GDP.

The main variable here is government spending, and the forces of austerity have suffered a total defeat. Therefore, I believe this "back of the napkin" forecast is relatively moderate.

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