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US Government Debt Crisis Hovers in the Background, Part 1

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Unless the underlying debt levels and budget deficits are dealt with, the ability of the US to finance itself will deteriorate.

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Greece and the other debt-burdened European countries are merely the first carriages in the derailment of the "Sovereign Debt" Express train service.

The failure of the congressional super committee to reach agreement on $1.2 trillion in budget cuts means that addressing the problem of US public finances is unlikely in the near term. The failure also casts doubts on the ability of US policy makers to overcome political differences to take actions to stabilize US government debt with potential consequences for the US and global economy

At Debt's Door

Ralph Waldo Emerson wrote: "The World owes more than the world can pay." The US certainly owes more than it can repay. US government debt currently totals over $14 trillion.

The US Treasury estimates that this debt will rise to around $20 trillion by 2015, over 100% of America's Gross Domestic Product ("GDP"). Even these dire forecasts rely on extremely robust assumptions about US growth around 5-5.5% per annum. Lower growth will translate into higher debt levels.

There are other current and contingent commitments not explicitly included in the debt figures reported by the government. Since July 2008, the US government has supported Freddie Mac and Fannie Mae (known as government sponsored enterprises ("GSEs")). This totals over $5 trillion in additional on or off-balance sheet obligations.

The debt statistics do not include a number of unfunded obligations -- the current value of mandatory payments for programs such as Medicare ($23 trillion), Medicaid ($35 trillion) and Social Security ($8 trillion). Projections show that payouts for these programs will significantly exceed tax revenues over the next 75 years and require funding from other tax sources or borrowing.

In addition to Federal debt, US state governments and municipalities have debt of around $3 trillion.

Apolitical Debt Blues

US public finances deteriorated significantly over recent years. Pimco's Bill Gross observed: "What a good country or a good squirrel should be doing is stashing away nuts for the winter. The United States is not only not saving nuts, it's eating the ones left over from the last winter."

In 2001, the Congressional Budget Office ("CBO") forecast average annual surpluses of approximately $850 billion from 2009-2012. Instead, the US government has run large budget deficits of approximately $1 trillion per annum in recent years. The major drivers of this turnaround include: tax revenue declines due to recessions (28%); tax cuts (21%); increased defense spending (15%); nondefense spending (12%) higher interest costs (11%); and the 2009 stimulus package (6%). German finance minister Wolfgang Schäuble told the Wall Street Journal on November 8, 2010 that: "The USA lived off credit for too long, inflated its financial sector massively and neglected its industrial base."

The US budget deficits and debt problems are apolitical, with bipartisan contribution to the accumulated mess in public finances.

Prior to the election of Ronald Reagan, deficit spending largely from military conflicts such as Vietnam and economic downturns created a national debt of around $1 trillion. President Reagan held firm views on government and the welfare state: "Government is like a baby. An alimentary canal with a big appetite at one end and no responsibility at the other." He quipped that: "Welfare's purpose should be to eliminate, as far as possible, the need for its own existence." But between 1981 and 1989, tax cuts and peacetime defense spending contributed to an increase in the debt of $1.9 trillion. The President was disappointed at the growing national debt, joking that: "[The deficit] is big enough to take care of itself."

Under President George Bush Senior, the national debt increased a further $1.5 trillion, driven by the costs of the first Gulf War and fall in tax revenues from a recession.

Under President Bill Clinton, national debt increased $1.4 trillion. There were large budget surpluses in some years, but increased spending added to the debt. The surpluses were driven by increased tax revenues from corporate and personal tax revenue gains due largely to the Internet bubble. In addition, Treasury Secretary Robert Rubin's "carry trade," shortening the maturity of US debt to take advantage of lower short term rates, resulted in interest costs savings.

Between 2001 and 2009, President George Bush Junior added $6.1 trillion in debt, driven by the wars in Afghanistan and Iraq, tax cuts and revenue losses of the economic downturn that started in 2007.

President Barrack Obama added a further $2.4 trillion in debt. The major contribution came from stimulus spending to counter the effects of recession, tax revenue losses due to the downturn, extension of the Bush tax cuts and the continued cost of two military actions.

Drowning in Debt

No borrower can incur debt on this scale without the complicity of its lenders.

The US government holds around 40% of the debt through the Federal Reserve ($1.6 trillion), Social Security Trust Fund ($2.7 trillion) and other government trust funds ($1.9 trillion). Individuals, corporations, banks, insurance companies, pension funds, mutual funds, state or local governments, hold $3.6 trillion. Foreigner investors hold the remainder including China ($1.2 trillion), Japan ($0.9 trillion) and "other," principally oil-exporting nations, Asian central banks or sovereign wealth funds ($2.4 trillion).

Until the global financial crisis, foreign lenders, especially central banks with large foreign exchange reserves, led by the Chinese, increased their purchases of US government debt.

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