Sunday, January 15, 2012

Grant's Interest Rate Observer vs. Paul Krugman on the U.S. Federal Debt

From Forbes:
Paul Krugman has a Nobel Prize in economics, so we should trust him when he says to relax about the “allegedly urgent issue of reducing the budget deficit” because governments, unlike families, don’t have to pay back their debts.

But still…Grant’s Interest Rate Observer (subscription required) this week has some disturbing statistics about just how hard it will be for Uncle Sam to pay back the debt the profligate Bush and Obama administrations have run up in the past decade. Citing the government’s own “Citizen’s Guide to the 2011 Financial Report of the U.S.”, Grant notes that the public debt has ballooned from $3.3 trillion in 2001 to $11 trillion today. This isn’t the intergovernment debt, like the Social Security “trust fund” securities that the government owed itself; this is claims by outsiders on government tax revenue.

Krugman tells us not to worry about the debt because most of it is intergovernmental. But the Citizen’s Guide provides food for worry: According to the government’s own accountants, Grant says, simply keeping the public debt at its current ratio to Gross Domestic Product would require an annual “primary” surplus of 1.5% of GDP for the next 75 years. The fiscal 2011 deficit was $1.3 trillion, or 8.7% of GDP. Grant observes:

Anticipating a swing to unbroken years of surpluses after the experience of George W. Bush and Barack Obama is a little like waiting for the Catholic Church to canonize Bernie Madoff.
And what’s a “primary” surplus? It’s tax revenue minus expenditures before interest expense. Krugman says not to worry about interest expense because it’s so low and foreigners will just have to keep sucking it up as the cost of investing with Team America. But again, the numbers are a little scary.

This fiscal year, the federal government will spend $241.6 billion in interest on $11.9 trillion in public debt, at an average rate of about 2%. (The Social Security “trust fund” earns billions more on Treasury securities that represent a solemn pledge between the current Congress and some future Congress to cut spending or raise taxes when retired Boomers outnumber working stiffs.) In fiscal 2006, the government spent $226.6 billion on $4.8 trillion at a rate of 4.8%. If the rate Uncle Sam has to pay rose to 5% — inconceivable, to be sure, but let’s just think out loud for a second — Grant calculates the annual interest tab to be $568.4 billion. That’s 4% of this year’s expected GDP and about half what we spend on defense. Let rates spike to 9% and the tab escalates to $2.6 trillion.

Bush bears a lot of blame for the financial crisis and ensuing debt explosion as federal tax receipts fell and entitlement spending remained constant. But Obama saw him one better. Since he took office he’s increased the gross debt by 66% to more than $15 trillion.

For now, it’s all easy to finance at low, low rates thanks to the U.S.’s status as holder of the world’s reserve currency. It reminds me of my own situation: My bank recently cut my mortgage interest rate by 75 basis points in exchange for a tiny fee, basically handing me a couple hundred bucks a month for no reason other than I had equity in my home. It’s those other saps, the ones who borrowed too much to pay too much for a house they can’t afford, who are struggling to make their payments each month and can’t refinance at lower rates....MORE