The National Debt Snowballs

Copyright © 2009, Greenwich Financial Management Inc., a registered investment advisor.

The lead article in the November 23rd issue of the New York Times was titled, "Federal Government Faces Balloon in Debt Payments." The article discusses how US Treasury officials are rushing to finance US debt for the long term at today's low rates. The national debt now exceeds $12 trillion. So far, the article noted, the world has been glad to take a heaping portion of our Treasury securities at such rates. But what if that appetite becomes sated? What's more, the Fed's role in containing inflation may come into conflict with the need of the US Treasury to keep interest costs low. In such a dilemma, the US dollar may become an unattractive asset for foreigners to hold.

People often confuse the federal debt with the federal deficit. The deficit is the annual shortfall. The debt is the cumulative amount owed. Another point of confusion is between real numbers (inflation adjusted) and nominal dollars. The most telling way to look at a nation's debt is in relation to its Gross Domestic Product (GDP), the sum of all the final goods and services created within the borders of an economy in a given year.

In September and October of 2004, we published a series of articles in this newspaper about the federal deficit. These are still available on the GreenwichFinancial.com Website. See The National Debt. We commented at the time that the policies of the Bush Administration--which involved cutting taxes, dramatically raising spending, and funding two overseas wars using gimmicky off-balance sheet financing—created fiscal perils for the future.

To see the estimated US debt in real time, here is a link: http://www.usdebtclock.org/. Currently, the debt represents about $40,000 per US citizen or about $110,000 per taxpayer. Currently, our debt amounts to about 95% of GDP. At the time of our September 2004 article, that ratio was a much more manageable 65.3%. The all-time high was hit just after World War II: 121.7%.

More recently, at the tail end of the Bush Administration and into the Obama Administration, we have initiated programs to bail out failing banks, insurance companies and automobile manufacturers. We are also using massive deficit financing to stimulate the economy, following a Keynesian anti-cyclical program. Arguably, it has been successful; we have averted a worldwide depression and are now starting to emerge from a recession.

Some may be familiar with "the national debt clock" that ticks on a billboard nearTimes Square. The clock measures the total estimated national debt, measured moment to moment, and it also estimated each family's share in this debt. When first plugged in 1989, the clock increased at a pace of $13,000 per second, and the right-hand numbers were a blur. In 1999, it began to decrease, after the Clinton Administration announced a reduction in the national debt via a series of buybacks of outstanding Treasury bonds. In its final display before being unplugged on September 7, 2000, the sign read: "Our national debt: $5,676,989,904,887. Your family share: $73,733." The sponsor decided to take down the sign because the backward direction might lead to complacency, the opposite of their aim. But the clock was reconnected on July 11th of 2004, as the national debt started to accelerate under the George W. Bush administration. The clock will soon be refurbished to allow it to display a quadrillion dollars (one thousand trillion!).

Regarding what would happen in the long run if governments use deficit spending to counteract a collapse in demand, economist John Maynard Keynes famously remarked, "In the long run, we are all dead." However, our children and grand-children may not be dead. The part of Keynesianism that is often forgotten is that it makes good sense to reduce national debt during times of prosperity. That was the salutary policy that was beginning to be followed by President Clinton. However, after that came the NASDAQ collapse in 2000, the 9/11 tragedy, and President Bush's allegiance to the doctrines of supply side economics. Ironically, in our quest to strengthen America militarily and economically, we so weakened our Treasury that real danger now lies ahead to our international standing.

Andrew Szabo CFA is managing director of Greenwich Financial Management Inc., a registered investment advisor. Questions call 917-796-8500 or e-mail Szabo@GreenwichFinancial.com). For more information, please visit http://greenwichfinancial.com/.