Sometimes commentators scold our political leaders for running up deficits that will have to be repaid by our children and grandchildren. I suspect that many politicians would gladly foist our nation’s obligations onto the next generation if they thought they could get away with it. But they can’t. Our nation’s profligacy will come back to haunt us while most of us are still alive. The day of reckoning — the day the U.S. federal government can no longer fund its programs through taxes and borrowing and is forced into making cataclysmic cuts — is at most 20 years away.
I am not making a prediction based on partisan prejudice. There is plenty of blame to go around. With Vice President Dick “Deficits Don’t Matter” Cheney providing cover, the Bush administration ran up the national debt from $5.7 trillion to $10.6 trillion during an eight-year recess from fiscal responsibility. Having castigated President Bush for saddling future generations with a massive debt, Barack Obama is now on pace to double the rate of debt accumulation. After less than eight months in power, Obama has increased the national debt to $11.8 billion. And his Office of Management and Budget has just issued a revised forecast stating that the federal government will add another $9 trillion to the national debt over the next 10 years.
Of course, that $9 trillion number assumes no significant changes in taxes and spending (Quick, someone call Nancy Pelosi!), and it assumes an up-beat economic scenario: a strong economic rebound, no recession over the next 10 years, low inflation and stable interest rates. (To review those assumptions, click here and go to the “economic assumptions” tab.) I think we can safely describe that $9 trillion number as a “best case scenario.” A worst-case scenario would be too hideous to contemplate.
A look at the graph above from the Office of Management and Budget (OMB) shows how deficits continue ballooning in the out years. By then, Baby Boomers will be retiring en masse. To pay for Boomers’ pensions, the Social Security Administration will have started drawing down the big pile of Treasury bills it accumulated when it was running a surplus. To pay for Boomers’ health care, Congress will have to do something not contemplated in the Obama forecast. According to Medicare’s trustees, the program is scheduled to run out of money by 2018. As long as the federal government is still solvent, however, Congress will find some way, by hook or crook, to keep the program afloat.
Projecting beyond 2019, the deficit numbers get even uglier as more Boomers retire and entitlement spending ramps up rapidly. A $1 trillion budget deficit will be a good year.
Of course, the Obama forecast depends upon a number of rosy assumptions. Let’s look at just one: interest rates. The Obama administration assumes that 10-year Treasury notes will creep up from 3.6% this year to no higher than 5.2% at the peak of the next economic cycle. In other words, even with the Treasury Department borrowing ever more massive sums and with the economy growing at annual rates of between 4.5% and 6.1%, with all that implies for private-sector borrowing, 10-year T-bills will remain stable at 5.2% for eight straight years. Do you believe that? I don’t.
Moreover, I will make the case in a future post that the U.S. is the beneficiary of a global capital surplus, which keeps interest rates low, but that the world economy will shift over the next 10 years to a global capital shortage, which will push interest rates higher. You can agree or disagree with me on that point, but there is one thing beyond dispute: Changes in interest rates will become a prime driver of government expenditures.
According to the Obama administration’s forecasts, interest payments on debt in 2009 will be $173 billion. By 2019, the administration says, interest payments will soar to $829 billion. Remember, that’s assuming 5.2% interest rates. But what happens if interest rates return to the level prevailing in 1990 when the 10-year note yielded 8.08%? Under those circumstances, interest rates would be roughly 60% higher and the interest on national debt would grow by an $500 billion a year over and above the forecast.
Using the Obama administration’s own numbers, we can reasonably conclude that the federal government will reach a state of chronic budget crisis within 10 years. Beyond the OMB’s 10-year time horizon, growing entitlements, the ballooning debt burden, the impending global capital shortage and an inevitable recession will push the federal government toward insolvency. At some point, the U.S. will reach the ultimate crisis in which foreign investors are no longer willing to purchase our sovereign debt at any price. When the federal government can no longer fund its spending, the fiscal crisis will precipitate the greatest political and economic upheaval since the Great Depression. We will have become Argentina.
Have a nice day!
(Chart credit: Wall Street Journal.)
