Greece defaulted on its national debt this week by not making a $1.7 billion payment to the International Monetary Fund (IMF). They face a very hard future. While what has happened in Greece this past week doesn’t compare to the financial situation faced by the U.S., there are some similarities – too much debt and spending, insufficient revenue, and it can’t pay its bills without borrowing.
What makes it really difficult for Greece is that it’s broke, in a depression, and does not have much control of its economy or finances. Terms are being dictated by its creditors – the European Union and the IMF – and the terms are continued austerity. Many economists agree that austerity is the worst thing to do in a depression, but because Greece was so far in debt at the start of the 2008 financial crisis, its lost control of its own finances.
The great debate raging whether austerity works, or if it’s strangling Greece’s economy, is not the most important thing to be learned from the Greek’s troubles. The paramount lesson is that a nation should never lose control of its finances due to fiscal irresponsibility.
Because America is the world’s largest economy and the dollar is still king, the world continues to lend us money to pay for our deficits. However, what has happened to Greece should be a warning to the U.S. and other countries living beyond their means.
A report from the non-partisan Congressional Budget Office (CBO) projects that total U.S. debt will grow from about $18.5 T at the end of this fiscal year, to $27.3 T by the end of 2025. This is a trend that cannot be sustained, and the report may be too optimistic.
The CBO report breaks down federal spending into three groups: Mandatory entitlement spending, discretionary spending, and interest on the national debt. A look at the numbers for each of these three groups is telling.
First, the CBO reports that mandatory spending is currently about 71% of government revenues. The report estimates that by 2025, mandatory spending will represent over 77% of revenues.
Second, interest payments on the national debt are also projected to grow quickly. The CBO reports that interest payments will grow from $275 B next year, to $827 B in 2025, and balloon from 7% of revenues to over16% of revenues.
Third, and most surprisingly, the CBO projects that discretionary spending will actually decrease from the current 37% of revenues to 28% by 2025.
Add them all up and the numbers total almost 122% of revenues for 2025, and a deficit of about $1.1 trillion for that year alone. As bad as these numbers may look, they could be a lot worse if the CBO report is underestimating expenditures, and using overly optimistic growth figures for Gross Domestic Product (GDP) and increased tax revenues.
For starters, if Congress fails to cut discretionary spending from 37% to 28% as projected, the deficit numbers will be much higher. All discretionary spending is determined through the annual appropriations process in Congress. It’s hard to believe that Congress will have the discipline to reduce discretionary spending almost 25%. Discretionary spending is made up of lots of important stuff, like: The military, Veterans’ benefits, education, transportation, research, agriculture, international affairs, environment, and other hard to cut items.
In addition, if interest rates rise more than the 2-3.8% CBO projects, interest payments will rise sharply and cost far more than the projection of 16% of revenues. Keep in mind that the interest rates paid on the national debt averaged 6.38% as recently as 2000.
Also, mandatory entitlement spending continues to grow and eat up an ever-larger portion of the budget. Social Security and Medicare are the two largest components of entitlement spending, and account for more than half of all U.S. spending. Because our country is aging rapidly, mandatory spending for these two programs will grow quickly. Without changes to entitlement programs, mandatory spending is projected to exceed 100% of revenue sometime in the 2030s.
Lastly, the CBO report is estimating annual GDP growth rate of 4.3% for the next decade. This number seems way too high. For the sake of comparison, the average annual growth rate of the first decade of this century was 1.8%, and has been 2.2% for the first five years of this decade. Even in the more robust economic times of the 1980s and 1990s growth was only 3.1% and 3.2% respectively. If the growth rate for the next decade is lower than CBO projections, tax revenues will go down and the deficit grows even larger.
Currently U.S. debt to GDP ratio is an already historically high 104%. Using CBO figures as projected, debt to GDP is estimated to remain at about the same percentage by 2025. But over the next ten years, if any of the expenditure estimates are too low, or growth is slower, the U.S. national debt will be higher. If both happen, the national debt will be much larger – possibly as high as 120-160% of GDP.
We are kidding ourselves if we think this can go on forever. It can’t. The numbers don’t add up. Something has to give.
And then there is China.
China’s GDP will exceed America’s GDP by about 2021, and is forecasted to be twice the size of U.S. GDP around 2030. Historically, the country with the largest economy has the most say in regards to global economic systems and rules, and its currency becomes the world’s dominate reserve currency.
Ten to fifteen years from now, the potential combination of a much higher U.S. debt, and the Chinese in control of rulemaking in international financial systems – including possession of the dominate reserve currency – could prove very troubling for America. If the day comes when America has difficulty borrowing money, we will most likely no longer be able to control all of our own finances, and may suffer many of the same unpleasant consequences as Greece.
We have some difficult choices to make, and need to decide what our priorities are. We can’t have it all. We need to choose how and where we want to spend our tax dollars, and how much we are willing to pay in taxes, but we must also begin moving towards a balanced budget.
By taking corrective action over a long period of time, we can reduce some of the pain associated with deficit reduction. But the ultimate goals need to include: Making gradual changes to entitlement programs over a 25-50 year period, eliminating annual deficits within a few years, and reducing the national debt as a percentage of GDP over time.
It’s very important that we take these steps soon, so we do not lose control of our finances. In order to achieve a lasting solution, it must be a bi-partisan plan. This means compromise on a grand scale in Congress. Given the current fiscal civil war between the two parties, we will most likely have to wait until after 2016. Meanwhile, the clock is ticking.
This is the fourth of a series of blogs that I plan to write about the economy and U.S. fiscal policy. I’m asking my readers to follow along as I first describe the current situation, and then begin to lay out what I think could be an effective bi-partisan comprehensive plan.
Links to related blogs:
China’s emergence as largest economy: http://www.commonsensecentrist.com/a-coming-new-order-in-global-financial-systems/
China and U.S. national debt: http://www.commonsensecentrist.com/china-why-deficits-and-the-u-s-national-debt-matter/
Budget concerns: http://www.commonsensecentrist.com/the-federal-budget-were-getting-boxed-in/
Economic growth: http://www.commonsensecentrist.com/growing-the-economy-the-road-ahead/
Fiscal policy: http://www.commonsensecentrist.com/leadership-not-misleadership/
Deficit reduction: http://www.commonsensecentrist.com/passing-the-buck-really-big-bucks-2/