Monday, March 23, 2009
One of the things we know in economics is that most people prefer to smooth their consumption over time. There are plungers; there are people who save too much and others who save too little, but on average people get it right. Because most people make less when they're young, they typically accumulate debt when they are young, only to retire it and accumulate wealth when you're old. For every individual, insolvency means you no longer can make a credible commitment to pay that debt down to zero in your lifetime.
The same applies to government. Governments cannot run Ponzi schemes, accumulating ever-higher amounts of debt. We need to demonstrate that, over time, the total national debt is on a path that leads eventually to its retirement. I've mentioned working on debt sustainability in Indonesia before; the goal there was to see if the government could repay a huge bank bailout that caused it to issue debt that was more than half of one year's GDP (to put that in our terms, that would be equivalent to a seven trillion dollar bank bailout here in the US.) In Indonesia's case, it was fine because it could always transfer oil royalties to the state budget to retire the debt.
Are we on a path headed to zero? The CBO's scoring last Friday of the Obama budget suggests that the proposal does not do so.
During the first hour of the Final Word on Saturday I put this graph up on Twitter for my listeners. The blue line represents the forecast of the ratio of federal government debt to GDP in the baseline scenario, which includes TARP and the stimulus bill. The purple line is that ratio as projected by CBO based on the proposed budget of President Obama. The report states:
The cumulative deficit from 2010 to 2019 under the President�s proposals would total $9.3 trillion, compared with a cumulative deficit of $4.4 trillion projected under the current-law assumptions embodied in CBO�s baseline. Debt held by the public would rise, from 41 percent of GDP in 2008 to 57 percent in 2009 and then to 82 percent of GDP by 2019 (compared with 56 percent of GDP in that year under baseline assumptions).I'm pretty confident a graph like this was one of the discussions that happened between CBO chief Doug Elmendorf and OMB director Peter Orszag last Wednesday. The White House is arguing that the Elmendorf forecast is more pessimistic, but they aren't saying too pessimistic. But the difference is $2.3 trillion in debt, and the WSJ reminds us this morning that this only includes the "down payment" on health care reform.
The way I look at this is to understand a concept called the "primary deficit". This is the deficit net of interest payments on the debt. Suppose you are paying on a credit card you've decided not to use any more. They are charging you high interest. You have to pay off at least all of the interest each month, plus some of the principal, for you to make any progress towards paying that debt off. Likewise, if the government wants to make any progress towards paying off its debt, it must collect enough in taxes, or cut spending enough, to not have to borrow all of what it needs to pay the interest on the debt. Now, it can hope to have an easier time paying back the debt because the economy grows, and it will if GDP growth should exceed the real interest rate it has to pay on the debt. But each year we add to the debt it gets a little harder. And doubling the debt-to-GDP ratio in ten years, with a forecast for real interest rates near 3% in their figures, that's quite hard to do.
The repercussions over the last three days have been astounding. Sen. Judd Gregg is sounding an alarm over the problem CBO raises. Nouriel Roubini says "A government that will issue trillions of dollars of new debt to pay for this severe recession and socialize private losses may risk becoming a Ponzi government if--in the medium term--it does not return to fiscal discipline and debt sustainability." In Canada Diane Francis thinks America may have reached its best-before date. And if the government is issuing into this environment $2.5 trillion in new debt that foreign governments no longer want to hold, this week starts to see the dollar slide and Treasury yields rise. Markets won't wait for Congress to figure this out; that market discipline that Robert Rubin once warned to Bill Clinton will come back in force. Maybe it's time for Mr. Rubin to make another visit to a young president.While working on this article my friend Ed Morrissey at Hot Air forwarded a note from a concerned citizen who had seen Sen. Gregg's interview. What does this do, she wondered, for her as a mother, a business owner, someone in her late 30s? The conception in this post on consumption smoothing owes a great deal to the work of Lawrence Kotlikoff, who foresaw years ago the clash between young and old when it comes to this debt. His book, The Coming Generational Storm, detailed how the impending explosion of Social Security and Medicare benefits would devour the next generation that had to pay those benefits. He's set up a financial planning service that uses some of these theories. Six months ago he wrote:
The decline in the dollar and our low national saving rate reflect an old policy of the government living beyond its means. If you look at all the extra consumption, it's occurring in large part among the elderly and, in large part, in the form of health care. This is not oldster bashing. We need to care for older Americans, but we need to do so in a way that doesn't constitute fiscal child abuse.
Some of this is changing -- some people are delaying retirement, others are saving more now -- but it's as if the current administration is turning its back on the very generation that brought it to office. If someone could get them the message...
UPDATE: Welcome Hot Air readers!