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Money Talks

By Dr. Gregg Dimkoff
Professor, Grand Valley State University
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I recently ran into an ex-student who had been in a course I taught a few years ago. He mentioned I advised the class there was no need to be overly concerned about the national debt.

I often talk about the national debt in class, and in the past, explained how the debt would become a problem only if future generations decided to repay it. I also pointed out the biggest enemy of debt is inflation, and that as years passed, the inflation-adjusted value of the debt would be less of a burden. At the time, the greatest problem with federal debt increases seemed to be Congress’s misallocation of spending, a natural result when there is no budget constraint.

My ex-student asked me whether I still felt the same way given the additional trillions of dollars of debt acquired over the past 3.5 years. Because of the unimaginable scale of indebtedness, my answer today is no.

Two forces are making the future look especially bleak. For starters, under current projections, Congressional Budget Office projections show the current $10.3 trillion debt level will grow to nearly $21 trillion in 10 years. The CBO is a non-partisan government department consisting of about 250 economists and public policy experts. One of its duties is making economic projections based on current economic policies. Its projections are about as accurate as any, but if there is a recession or two during the next 10 years — and it will be unusual if there isn’t at least one — the federal debt likely will be even greater than CBO projections.

The other factor causing angst about the federal debt is the pervasive lack of willpower to do anything about it. As I write this column, Standard & Poor’s has just warned it will downgrade the rating of U.S. debt in the next year or two if Congress doesn’t change its spending addiction and take positive economic actions to reduce indebtedness. A downgrade from the current AAA rating would be the country’s first since bond ratings began.

Why the warning? It reflects the embarrassing spectacle of Congress trying to trim the federal budget. You’ll recall how close our fine House and Senate members came to shutting down the government because they couldn’t agree how to cut $38 billion. At $8 billion of new federal debt per day (March’s average), $38 billion is equivalent to five days of cuts. The “cuts” were mostly accounting gimmicks, not real reductions. In fact, at least one budget expert claims the actual cuts amount to less than one-half billion dollars.

Adding to the spectacle, President Obama introduced his plan on April 13 to cut around $4 trillion over the next 12 years. A quarter of those cuts will come from interest savings, supposedly because the U.S will be borrowing less. Reducing total debt by $2 trillion and keeping it at that lower level for 10 years saves about $100 billion per year. Over 10 years, the savings amounts to $1 trillion of interest. If interest rates increase just 0.5 percent, however, there won’t be any interest savings. With interest rates hovering at the low end of historical levels, it seems more likely rates will rise enough to wipe out the President’s projected savings. No problem: The President’s plan is to raise taxes by $1 trillion if it looks like his $4 trillion goal won’t be met.

If Congress doesn’t have the will to make meaningful budget cuts, and the President’s proposal is nothing more than a campaign speech, we’re doomed. Barring some kind of miracle, what could happen because of a $10 trillion increase in federal debt? For one thing, much, much higher interest rates on federal debt. We need look no further than what’s happening in Greece. Its ratio of debt to GDP is now at 150 percent, and because of the risk of a default, world financial markets now require a 20 percent interest rate on Greece’s government bonds. Greece is all but bankrupt.

U.S. debt stands at 91 percent of GDP. Doubling the debt level over the next 10 years likely will drive up the ratio beyond 150 percent. Long before then, Standard and Poor’s will downgrade the country’s credit rating, driving up interest rates. At that point there won’t be bailouts from anyone, and even confiscating all the income from everyone earning over $250,000 per year won’t be enough to save the country. The middle class will take a hard hit from either much higher income taxes, or severe cuts in their standards of living, or both.

What’s the solution? We have no choice: Significant cuts must be made to our country’s three sacred cows, Social Security, Medicare and Medicaid. Virtually every U.S. adult will be affected. No one will be happy about the cuts, and everyone will complain. Do we have the stomach for that? If not, we’re doomed.

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