U.S. is Confronting a Federal Debt Crisis

Original Article

A year ago, Standard & Poor’s fired a shot across America’s bow, downgrading its coveted AAA rating to a AA+. S&P’s rationale for the rating cut was specifically that Congress’s Budget Control Act “fell short of the amount … necessary to stabilize the general government debt burden by the middle of the decade.”

For several weeks, media pundits and Washington policymakers were jolted out of denial that government deficit spending could continue in the same trajectory.

Congress formed the Joint Select Committee on Deficit Reduction — aka “the super committee”— as part of the Budget Control Act. Its mandate was to make recommendations within three months to reduce federal expenditures over 10 years by at least an additional $1.5 trillion on top of the $917 billion already agreed to — for a total reduction of $2.4 trillion.

Three months passed without agreement by the super committee on any spending cuts. The sense of urgency dissipated and a historic opportunity to bring measurable and real discipline to spending was lost. Meanwhile, the federal government entered its fourth straight year projecting a $1.25 trillion deficit without a plan or a budget. In the preceding three years of the Obama administration, the annual deficit averaged $1.34 trillion a year. Previously, in any single year in the country’s history, the worst deficit had been $459 billion — 66 percent lower.

Looking back, when Obama took office in January 2009, the total U.S. government debt stood around $10 trillion. Now, slightly more than three and a half years later, more than $5.5 trillion has been added to the national debt.

The U.S. debt clock is about to roll over and officially register $16 trillion. This out-of-control spending and debt is the primary reason why all three credit rating agencies — Moody’s, Fitch and S&P — now have negative outlooks on the U.S. government debt, all but assuring downgrades and the loss of remaining AAA ratings for the United States in the near future.

If credit rating downgrades are too abstract, the riots and near collapse in Greece, Spain and the Eurozone should have infused Washington with a sense of urgency to undertake structural reform of taxes and entitlements and make deeper cuts in government spending.

Postponing the day of reckoning on deficit spending doesn’t just kick the can. It brings us closer to the next financial crisis — a collapse in the government bond market — which would bring chaos to the streets and make 2008 look like a cakewalk.

In fact, a debt-driven collapse of the U.S is closer than most Americans realize. Consider what has happened in Spain and Italy — the 12th and eighth largest economies in the world. Just 10 months ago, Spain and Italy carried AA ratings, but today their debt ratings have plummeted to near junk at Baa3 and Baa2 respectively, driving their 10-year government bond yields above 6 percent.

Since the deficit-to-GDP ratio of the United States is worse than that of Spain and Italy, higher funding costs for U.S. debt may come sooner than Fed Chairman Bernanke forecasts. Recession or war would further blow out the deficit and accelerate debt rating downgrades. Either crisis could cause U.S. debt service costs to sharply rise and potentially trigger a downward-spiral ending in a failed U.S. Treasury auction and a subsequent liquidity crisis. As happened in Greece and now recently in Spain, the U.S. could face funding shortfalls only solved by money printing that would likely trigger unacceptable inflation.

A third round of quantitative easing is really no more than a fancy term for money printing, which our current deficit spending requires. The Federal Reserve has shot all its bullets — having lowered federal funds interest rates to zero.

Sadly, things are worse today than they were a year ago when the U.S. lost its AAA rating by S & P. The national debt has grown by nearly 11 percent while the economy has grown by only 2 percent. And over the last four years of various government spending programs, debt has grown by 60 percent while GDP has grown only 7.7 percent. So much for the benefits of Keynesian stimulus. Washington’s policies have left the country without shock absorbers or an effective insurance policy to counter another crisis.

But that is why we have elections. Americans likely to vote are better informed, and polls show they are more inclined than ever to send new blood and real statesmen to Washington. Clearly, we need new leadership at the top and a majority in both houses of Congress who have experience in creating private sector jobs.

Scott S. Powell

Senior Fellow, Center on Wealth and Poverty
Scott Powell has enjoyed a career split between theory and practice with over 25 years of experience as an entrepreneur and rainmaker in several industries. He joins the Discovery Institute after having been a fellow at Stanford’s Hoover Institution for six years and serving as a managing partner at a consulting firm, RemingtonRand. His research and writing has resulted in over 250 published articles on economics, business and regulation. Scott Powell graduated from the University of Chicago with honors (B.A. and M.A.) and received his Ph.D. in political and economic theory from Boston University in 1987, writing his dissertation on the determinants of entrepreneurial activity and economic growth.