US Debt Disaster

Dave Killion — August 10, 2011

Antony Zegers (a fellow Victoria Libertarian Book Club member) emailed this contribution to me, with permission to post it. Enjoy –

“In a recent discussion with a friend about the debt ceiling debate, it was noted that the US federal debt after the Second World War was around 120% of GDP, which is significantly higher than the “official” number now.  The government at the time was not only able get the budget back in order, but this period ushered in several prosperous decades through the 50s and 60s.  So if the current debt situation is less severe, could we be poised for a similar happy resolution?

The following points may be worth considering:

1. The debt then was held mostly domestically through war bonds, so when it was paid back it remained in the US economy.  Much of the current debt is held by foreigners, especially central banks (particularly China and Japan).

2. The maturity schedule of the debt right now is very short.  Back then much of it was in 30-year bonds, so interest payments were stable and predictable.  The average maturity is around 3 years right now [1].  This means that even if they don’t go further into debt (which obviously they will) they have to roll over a large proportion of the debt each year.  This makes the debt very vulnerable to changes in interest rates.  The situation right now is analogous to a teaser rate on a mortgage, if rates go up they will have huge problems.  And rates will have to go up at some point.

3. The “official” debt does not include many of the liabilities that the government is on the hook for.  The “Unfunded Liabilities” of Social Security, Medicare, and Obamacare are huge.  This will either mean huge future expenditures (making it harder to pay down debt), or cuts to these programs.  Also, Fannie, Freddie, and the FHA are holding many trillionsof dollars in mortgage-backed securities.  Much of this stuff is probably worthless, and the government is on the hook for it.  There is also the state-level debt to consider.  Will the federal government stand by as states go bankrupt, or will it be called on to bail them out?

4. The GDP numbers are inaccurate.  Current GDP numbers are skewed by excessive borrowing and consumption spending, they do not really represent the productivity of the economy and the ability to raise revenue to pay down debt.  Inaccurate inflation numbers also artificially inflate the GDP stats.  GDP will likely stay stagnant or shrink in the coming years.

5.  After the war they were able to cut the massive unproductive war spending.  After the Second World War, the US government cut spending by about 65% from 1945 to 1948 [2]!  Imagine how uthinkable that would be nowadays.  The Keynesian-influenced economist at the time warned that with would create a huge depression, and advocated keeping the munitions industry going to avoid job losses.  Of course the opposite happened, and the resources freed by this spending cut unleashed a huge productive forces, paving the way for prosperity through the 50s and 60s, and also made it possible to pay back the war debts.

So what will happen?  Possible options are:

A. Pay the debt back honestly: This would require massive spending cuts, probably tax hikes, and putting a stop to inflation, which would mean higher interest rates and would throw the economy back into recession.

B. Default honestly.  This would annoy the foreign central banks, would cause much of Wall Street to go bankrupt, and would throw the economy into recession.  But at least with this option, you do not wipe out the private wealth of the people, and you have a clean slate to restructure the economy and regain prosperity.

C. Default dishonestly.  This will be done through inflation, basically printing money to pay the debts.  This is the most politically palatable option, because it allows governments to keep spending, delays the day reckoning into the future, and allows politicians to escape blame.  The problem is that by devaluing the money, you wipe out the wealth of the middle class, and inflict huge harm in the economy through capital consumption, and preventing the necessary restructuring. The most extreme possibility would be hyperinflation, which totally destroys the economy.

Option C is by far the most harmful option. Unfortunately, as evidenced by the recent raising of the debt ceiling, this seems to be that path we are headed down.”





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