Historical Overview of Federal Finance: Debt and Interest
It’s time to conclude my overview of U.S. federal finance for this year, and for a while, with a discussion of the national debt in the context of all our other debts, and the values of those who are running them up. One spreadsheet with data and charts on federal revenues, expenditures and debts from the 1970s to the present, previously linked in this series, is here. A second, new spreadsheet, on U.S. debts of all kinds from 1952 to the present, is here. I suggest grabbing these spreadsheets and printing out the charts in the latter before reading on. In prior posts, I showed how U.S. federal taxes as a percent of GDP had fallen to the lowest level of my working lifetime, and of the current political era, by fiscal 2011, at just 14.4% of GDP. And federal spending had soared to the highest level in recent history, at 25.3% of GDP. As a result, over the past five years the federal deficit has soared to levels unheard of for a half century, and the total federal debt as a percent of GDP has jumped to levels not seen since the aftermath of World War II.
Some of this is the result of the Great Recession and the response to it, and may pass. But some of it is merely a culmination of a “buy now, pay later” era that has gone far beyond the finances of the federal government. As a result, the United States is at risk of financial disaster. The biggest difference between us and Greece is that, for the moment, other countries and the people within them are willing to lend to the U.S. federal government at zero percent interest. On the assumption that the government will impose whatever harm is necessary on younger generations in the future to pay them back.
Let’s complete our discussion of the first spreadsheet, “Overview of Historical Federal Finance.” In a responsibly run country, one would expect government debt to rise as a percent of GDP in a recession, when falling employment and income reduce tax revenues and greater economic distress requires a response by the community to avoid deprivation. And one would expect government debt to fall as a percent of GDP in economic expansions, as tax revenues increase and fewer people require assistance.
Attempting to take the business cycle out of it by examining roughly comparable economic years, however, one finds that the gross U.S. national debt increased from 32.4% of GDP in F Y 1979 under Jimmy Carter to 65.3% of GDP following the Reagan and Bush I administrations. Some of you may recall H. Ross Perot running for President as a third party candidate in 1992, making the national debt his central issue, and attracting 19.7 million votes, the most by a third party candidate ever by a wide margin. You may recall real estate executive Seymour Durst installing a national debt clock on one of his office buildings to call attention to the issue.
In FY 1995, the net interest on the national debt had reached 3.1% of GDP, with the gross interest at 3.58% of GDP (more on the difference later). That was the money that had to be paid in taxes for which nothing was received in exchange. Dividing the interest payments as a percent of GDP by the debt as a percent of GDP, one finds that the average interest rate paid on the national debt was 5.4%. A few years earlier, while saving for the downpayment for a house, my wife and I invested in a two-year U.S. Treasury note. The interest rate was more around 9.5%, compared with 0.3% today. Consider for a moment that right now, in financial circles, they are saying that if the interest rate on Italy’s national debt exceeds 6.0%, the country will enter a downward spiral from which it can never recover, because that country’s national debt exceeds 100.0% of GDP.
Back in the U.S., the national debt leveled off for a while as the Bush I and Clinton Administrations raised taxes and cut spending. The gross debt was 62.1% of GDP in FY 2004, despite increases during the early Bush II administration. The national debt clock had been decommissioned. But the Bush II-era national frat party was just starting.
Look at the “Debt Chart” within the “Overview of Historic Federal Finance” spreadsheet. As during the Reagan Administration, during the Bush II Administration the national debt continued to rise as a share of GDP even as the economy expanded. That meant that the phony economic growth associated with the housing bubble was covering up a profoundly structurally unbalanced budget, a fact that was exposed when the bubble burst. The gross national debt exploded as a percent of GDP in the last two Bush budgets, in FY 2008 and FY 2009. And then in FY 2010 and FY 2011, the Obama Administration and the Democratic Congress barely bent the curve. By the latter year, the gross national debt had exceeded 100.0% of GDP, as in Italy and Greece. The national debt clock was switched back on in 2004, and is still running.
But the net interest on that national debt equaled just 1.4% of GDP in FY 2011, much less than in 1995. Dividing gross interest by the gross national debt, one finds an average interest rate of just 2.1%. At the interest rates of 1995 and earlier, the U.S. federal government would be facing a huge interest rate burden that could only be met by massive tax increases, spending cuts, and a downward spiral of borrowing. Over and above what we already face. Thus, financial disaster is being avoided only because interest rates are that low. How long can that go on? In Japan, it has gone on for 20 years, but that is because the Japanese people save so much as individuals and are willing to invest in their own country’s bonds at near zero interest rates, in part because inflation is also near zero. But the U.S. is dependent on foreign money.
As a result of all that debt, in other words, we are on thin ice between having younger generations being somewhat worse off indefinitely, and having everyone become much worse off very suddenly. Why did this happen? What does this mean? I used to blame politicians, and at the national level, Republican politicians in particular. With additional evidence, however, I’ve spread the blame more broadly, and coined the term “Generation Greed.”
The additional evidence may be found in the new spreadsheet, “Total Credit Market Debt Outstanding Stat Abst” which is, once again, linked here. It uses Federal Reserve data on all U.S. debts, public and private, from 1952 until recently, downloaded from the Statistical Abstract of the United States and than partially updated for 2011 last week based on the Fed’s Z1 data release. If you click on and print the “Total Debt” chart, which I referenced in the first post in this series, one sees that it wasn’t just the national debt that exploded as a percent of GDP during the Reagan and Bush II eras and leveled off in between. It was U.S. debts in general, which had previously increased little between 1952 and the late 1970s, the era when the average pay level of most American workers was rising. It is only during the years from 2009 to 2011 that total debt began to fall.
Now click on the “Debt Chart” tab to see that total debt broken out into categories. First look at the “Federal Government” line. The vertical lines show the different Presidential administrations by fiscal year, but this is calendar year data (the federal fiscal year ends in October). The chart shows the national debt falling from the early 1950s to the early 1970s, leveling off during the 1970s at less than 30.0% of GDP, and then soaring in the 1980s and early 1990s, during the Reagan and Bush I Administrations, eventually reaching a high of 50.0% of GDP during the last Bush I budget. Federal debt then fell as a percent of GDP during the entire Clinton Administration, reaching a low of 32.9% of GDP in 2001, with the last Clinton Budget. It has since soared to 69.3% of GDP in 2011, more than doubling as a share of the economy.
Of course the national debt at 69.3% of GDP as measured by the Federal Reserve is less than the 100.0% of GDP-plus in federal budget statistics, just as the “net interest” paid by the federal government is less than the “gross interest” paid. The difference, in debt and interest, is what is not included in the Fed’s statistics and in “net interest.” This data does not include debts of the federal government to itself, and interest paid to itself. Or specifically debts of the federal government to its trust funds, and interest paid to its trust funds.
With most of it owed to the Social Security trust fund, which it seems those in the know believe is not real debt because, having spent all the extra money workers put in for 30 years leaving IOUs in its place, the federal government doesn’t have to pay it. As soon as there wasn’t any extra Social Security money to pay for the rest of the federal government, politicians – particularly Republican politicians – began talking about taking benefits away from those under age 55, as I noted here. While Democratic politicians continue to close their eyes, preferring that younger generations not be officially screwed until later, so it can be said to be due to “circumstances beyond our control.”
Before moving on to the private sector, let’s consider state and local debts. These get lost in the overall “Debt Chart” because of the huge upward move in other categories, but if you look at the chart just for “State and Local Debts” you’ll see that looking beyond the cycles, the general trend has been for state and local debts to increase as a percent of GDP.
Total U.S. state and local government debts increased from 8.6% of GDP in 1952 to 14.8% of GDP in 1971. This, however, was a period of massive infrastructure investment in the United States, investment the likes of which has not been seen since. So while later generations were burdened by the debts, they also benefitted from the investments. State and local debts than fell as a share of GDP through the 1970s and into the early 1980s. I recall from that time that one response to concerns about the (then tiny) national debt was that it was offset by state and local government surpluses. Then the current political era started with the election of Ronald Reagan, which cemented the winning political strategy – more government services and benefits with lower taxes.
You may recall from my prior post in this series, on federal spending as a share of GDP in minor categories, that there was a downward trend in federal spending on infrastructure starting in the Reagan Administration and continuing until an (almost certainly temporary) reversal as a result of the Obama Stimulus Plan. Federal spending on infrastructure, education, natural resources, and research and development combined fell from 2.62% of GDP in FY 1979 under President Carter to 1.63% of GDP in FY 2004 under Bush II, before rising to 2.04% of GDP in FY 2011 under Obama. Infrastructure, rather than the other categories, accounted for much of the decline.
But federal infrastructure money is generally just passed on to state and local governments, which actually spend it. I also found, using data from the Governments Division of the U.S. Census Bureau, that following a big drop off at the end of the national development era, state and local government spending on infrastructure construction had not fallen significantly from the mid-1970s to the present. So if the U.S. has been disinvesting in the infrastructure in a physical sense, it has been due to getting bad value, not spending less money. At least so far. Thus the generational equity question, as I framed it in the prior post, was whether this relatively steady construction spending despite the decrease in federal tax funding was paid for by an increase in state and local tax funding, or by of an increase in state and local debt.
The answer appears to the debt. State and local debts in the form of tax-exempt bonds increased from 12.6% of GDP in 1979 to 19.9% of GDP in 2011. That, moreover, is an average. As I noted in this post, some states have a much more sold-out future than others, with New York State in general and New York City in particular right near the top of the list. We know this from the fiscal crisis at the MTA. Yes the transit system has been restored and maintained so far, but most of the money used to do so has been borrowed. With more and more of the agency’s future revenues going to past debts, there is no money to improve, expand or even maintain the infrastructure going forward. The MTA just keeps on borrowing until eventually it will collapse.
After years of net borrowing, state and local debts actually fell in 2011 for the first time since 1996 according to data released last week, a fact ballyhooed by Bloomberg News. “U.S. state and local governments reduced their debts last year for the first time since 1996 as political aversion to borrowing cut supply of municipal bonds and fueled a market rally.” "You have an aversion to higher taxes and an aversion to borrowing," an analyst told this source. "Politically, debt, borrowing and Wall Street are dirty words."
But debt is only “politically dirty” if people know about it, and there are plenty of off the books debts at the federal, state and local levels that are not reflected in actual bonds. For nearly two decades, state and local governments have not put enough money in their pension funds to pay for the retirement benefits public employees had been promised, and at the same time inflated the cost of those benefits in exchange for the political support of unionized public employees.
The preponderance of guilt between the taxpayers who didn’t put enough in and the unionized retirees who grabbed too much out varies from place to place. New York City, with among the nation’s highest combined state and local tax burdens, is perhaps the place with the most innocent general public and the most guilty unions. And one of the worst problems.
But there are massive hidden debts in the form of unfunded public employee retirement benefits just about everywhere. The question is will the on- and off-the-books debts be paid, or will public services collapse? In New York City, based on the 1970s experience and the distribution of political power today in Albany, the answer is surely the latter. In the 1970s, following the retroactive pension enhancements and debts of the Lindsay years, public services were gutted. The police stopped protecting people from crime, the first of several generations of children was (except for those in special deal schools) not educated, garbage filled the streets and parks, the infrastructure was left to rot, the subways barely ran, and the bag ladies froze to death in the streets. The debts and pensions got paid. New York has now repeated the debts and pension deals that led to that disaster. But this time, those policies have been followed statewide – indeed nationwide.
What has happened for 30 years in state and local finance is directly contrary to my personal values. I believe in saving for and investing in the future, so tomorrow is always better than today. On the grounds that missing what you never had is not as painful as downsizing your lifestyle. A short term party in exchange for a diminished future is not what I want for myself, my family, my children, or my community. We’ve never run a credit card balance, paid off or mortgage and student loans as soon as possible, lived on as little as we could and put as much money as possible aside when we were younger, and didn’t expect to have nearly as many years in retirement living off others as we worked, despite those savings. And though there are disaster scenarios in which we could become worse off, we are generally well off, comfortable and secure as a result. I’m not worried about myself, or my wife and I as a couple.
It is my children and community that I’m worried about. I have followed public finance closely, and collected data on it, for more than 20 years. At first, looking back at the recent past for New York City and State, I saw recovery from the 1970s even as the federal budget deficit exploded. The debts and pension obligations gradually fell as a percent of the income of city and state residents, allowing services to be restored and the gap between taxes here and elsewhere to close a little. But more and more, starting in the early 1990s, I saw the same policies that had led to disaster once before being repeated.
I became more and more concerned and upset, eventually leaving public service to run for (or rather against) the New York City state legislature, a main source of all the future selling that was occurring on the public side, in 2004. Most people weren’t interested in my generational equity concerns at the time. The media certainly paid no attention. More are interested now. But it is too late. In fact, it was probably too late then.
To see why no one cared that our collective future was being sold down the river, look at the “Debt Chart” and consider the choices American businesses and consumers were making during this era. Far from caring about the future of the community, they apparently didn’t even care about their own futures! In Italy, and also in Japan, people have been content to have their countries sabotage their collective futures by going deep into debt. But they have the opposite attitude when it comes to their own personal finances, where they save and save to assure their own future and that of their families. There are no such inconsistencies in the United States.
Consumer debts soared in the 1980s, leveled off a little, then really soared in the 2000s. It’s just shocking. I was trained as a regional economist, not a macro-economist, and I wasn’t tracking this. Yes I was aware some people were living beyond their means, running up their credit cards, sucking all the equity out of their homes through additional mortgages and spending the proceeds, rather than paying off their mortgages and burning the paperwork. I was aware that the U.S. ran a persistent trade gap and American’s borrowed from the rest of the world to pay for imports. But I had no idea of the scale. From around 45.0% of GDP in my formative years of the 1970s, total consumer and non-profit debts rose to a peak of nearly 100.0% percent of GDP in 2007. This during a period when the whole baby boom was in its working years, when savings should have soared as people prepared for retirement.
This has been a Social Tsunami of people destroying their own futures, as well as their collective future, in a loud shout of “I want for me now!” Someone decided to give Americans enough rope to hang themselves. And hundreds of millions of people grasped it with both hands.
Although dwarfed by the rise in federal and household debts, non-financial businesses have also been put in hock by those who have run them, as is clear when the debt-GDP ratio for such businesses is graphed separately. Here again, cyclical downturns aside, the trend is up, up, up, from just over 30.0% of GDP in 1952 to a peak of nearly 70.0% of GDP in 1987, just before the stock market crash, to an even higher peak of nearly 81.0% of GDP in 2009. All that business debt has meant higher returns in good years, but a greater chance of disaster in bad years. The higher returns in good years mean more executive pay, not higher returns for stock and corporate bond investors. The investors, including public employee pension funds, were left with the disasters.
But the real kings of debt have been financial businesses. Their debts were less than 5.0% of GDP in 1952, but soared and soared to nearly 120.0% of GDP in 2008. Once again all this debt has meant little if any return for investors, but plenty of plundered wealth for those at the top. Until the debt mountain collapsed in 2008. You know all those New York City and New York State taxes paid by the financial sector in recent decades? This is the ever-expanding pile of debt that made it happen. Could it go on forever? We found out in 2008.
And what has happened since 2008? Household debt has fallen by 9.0% of GDP. Non-financial business debt has fallen by 1.2% of GDP. Financial business debt has fallen by nearly 30.0% of GDP. And to keep our debt-driven economy from utter collapse and avoid a second Great Depression as this deleveraging went to, federal debt has soared by nearly 25.0% of GDP – by two-thirds as much as private debts have fallen. A large share of all that private debt the government allowed people and firms to run up has thus been shifted onto the government itself, just as Reinhardt and Rogoff predicted in This Time Is Different. And now, with the losses having been socialized (still going on) some politicians say the federal government will no longer be able to meet the needs of younger generations when they reach old age as a result.
Could the Bush and Obama Administrations have chosen differently? Well, they could have elected to save the government and its ability to meet basic human needs while allowing the private economy to collapse, in the hopes of a later revival, as in Iceland. In effect, that’s what the U.S. did during the Great Depression – it did not act until bankruptcies had wiped out much of the paper wealth in the country, and then only to reduce the pain of those at the bottom due to the fallout. The result was the worst decade in U.S. economic history, but one that ended with the most equal distribution of income and wealth in its history.
Regardless, we will be paying for the past 30-plus years for a long time. The recovery so far? Hair of the dog that bit you. Even more consumer debt, which isn’t any more sustainable than more federal debt. And going forward, a lower and lower standard of living. How will it play out? Reinhardt, who has been right before, predicts debts will be inflated away through “financial repression.” “Faced with a private and public domestic debt overhang of historic proportions, policy makers will be preoccupied with debt reduction, debt management, and, in general, efforts to keep debt-servicing costs manageable. In this setting, financial repression in its many guises (with its dual aims of keeping interest rates low and creating or maintaining captive domestic audiences) will probably find renewed favor and will likely be with us for a long time.” The winners will be those who can get their money out of the country safely, and those who have their income automatically increased for inflation – Social Security recipients, unionized public employees and retirees, perhaps even the one percent. The losers will be those who fall behind inflation, probably everyone else and small savers.
Look at that debt chart. I mean, just look at it! My wife and children have been amused by the local “Shit People Say” video series. “Shit New Yorkers Say.” “Shit Native New Yorkers Say.” “Shit Brooklyites Say.” “Shit Park Slope Parents Say.” Look at that chart, and then see if you can stand to listen to any of the candidates for President. You know what the 2012 campaign is? “Shit People Who Are Full of Shit Say.”