Fiscal irresponsibility 14: Debt crisis and government failure

(This is my article yesterday in the lobbyist.biz with original title, Debt Crisis and Government Failure)

A debt crisis is a situation where a debtor – a person, corporation, government, or other entities – is in a situation where it may not be able to pay its obligations to its creditor/s despite earlier promises or contract of paying on time, or on a renegotiated payment period.

Government failure is inability of government to provide or supply what it has vowed to the citizens. The more functions or welfare that government promises to the people, the bigger the danger of government failure. Among the most important functions of government is the promulgation of the rule of law.

When government borrows like crazy with a promise to its creditors that it will pay on time, then says that it may not be able to fulfill such obligation, that it may default some of its debt payment, then government is saying that it may throw out the rule of law on its debt contract.

The debt crisis of the US federal government was solved temporarily last August 2 when the US Congress enacted another law raising for the nth time the government’s debt limit. Thus, the debt uncertainty was “solved” temprarily by having more debt. Thus, the debt crisis of 2011 was only postponed into the future, maybe until next year, or next 2-3 years.

Now the US government got a big slap with a credit downgrade. For the first time, its AAA rating by S&P was downgraded to AA+ with a negative outlook, meaning another downgrade in the coming months and years is highly possible.

Low credit rating means lower possibility of that debtor that it can fulfill its debt contract on time and at the stipulated terms. Thus, higher risk for its creditors. So creditors will demand higher interest rate to reflect the possible danger in the future of the debt contract to be reneged or renegotiated.

I doubt that the US government, and many European governments for that matter, will realize their self-inflicted government failure, then blame market failure somehow for the mess. But the lesson is actually very clear and simple: If you live beyond your means, if you spend much higher than your income or revenue, then resort to endless borrowing to finance the funding gap, the natural resort is 100% predictable: ever higher debt.

A modest person or government would recognize the folly of such unsustainable lifestyle, and would solve such debt by cutting spending and/or raising income, not by more borrowing. A lower credit rating in fact should be a good opportunity, a good rationale, for the heavily indebted person or government, to cut its less important spending as there is higher penalty for more borrowing.

The US government has trillions of $ of assets and properties to sell if they really wish to solve that endless debt problem. Privatization of some of those assets is a good solution as the government can continue many of its projects and welfare programs, pay many of its debts and soon reduce the interest payment burden, without resorting to more taxation of the citizens.

But for many governments, rich and poor alike, more borrowing, even more taxation, is the usual solution. Today’s politicians who get today’s borrowings will not be around when those debts will fall due in the future. This is one moral hazards problem in government that largely explains why the debt problem tends to worsen rather than mitigate.

In short, hypocrisy is much larger than sincerity.
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See also:
Part 11, US debt default talks, July 18, 2011
Part 12, More on US debt default, July 28, 2011

Fiscal irresponsibility 12: More on US debt default

Last week, July 21, I wrote this:

In less than two weeks, on August 2, the US federal government's public debt of $14.294 billion threshold where the government can no longer borrow, will be reached. That is why the noise on "debt default" is becoming louder. See my paper on this 3 days ago, Fiscal irresponsibility 11: US debt default talks.

Source of this chart, The Economist, America's public debt: Down to the wire, July 18, 2011.

Please note that these figures are public debt by the federal government alone. Not included here are debt by local governments -- states, counties and cities. Those lower government levels have their own share of debt crisis too, like the state of California.

The extent of fiscal irresponsibility, of persistently living beyond their means, criss-crosses various levels of government.

The next chart is from Dan Mitchell of Cato, Mr. President, Here’s that Balanced Approach You Keep Demanding, July 15, 2011.

He made a 5-10 years projection in both US tax revenues and federal spending. From the data he gathered from OMB and CBO, projected revenues will remain at 18 percent of GDP, similar to the average figure for 1950-2000. But projected spending will be 23.6 percent of GDP, much higher than the 50-years average of 19.8 percent of GDP from 1950-2000.

Over-spending, then over-borrowing to finance the excess spending. This is the plain and simple reason why the US government is digging deeper in public indebtedness and the various economic, financial and political problems attached to it.

There should be other potential government revenues aside from more taxation. Privatization of many government assets (land, corporations, banks, universities, hospitals, etc.) is one important policy tool. But it is not palatable to the political class. And this attitude is not unique to the US. There is deep insecurity and hypocrisy in the political and bureaucratic class not to entertain this policy tool.
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Today, July 28, 2011

There is a good graphics I saw from CQ.com, Debt limit of the US federal government from 1980 to 2011. There are 4 lines there. Topmost is US GDP, next (light brown) is the debt limit, below it is the debt subject to debt limit (light green) and further below (dark green) is marketable debt.

The debt limit started rising more frequently since 2003. And the gap between the size of GDP and debt limit used to be far until about mid-2008. Since then, the gap between the 2 has become narrower and narrower. The two almost intersected in early 2010. That's when the US government was bailing out many big private corporations using money it borrowed from many sources. Click these charts for a larger image.

This table is interesting. It shows who lent how much to the US federal government, as of end-March this year.

Domestic private investors lent $3.23 trillion while foreign investors, mostly governments and foreign central banks, lent $4.48 trillion. Of the latter, the Chinese government lent $1.15 trillion, Japan government lent $0.91 trillion. Graph source, Who holds the federal debt.

Chart source below, The Economist, Daily Chart July 28th 2011. It shows the overall debt over GDP ratio for both the US and Canada. I just copy-pasted them from the interactive graph of The Economist. All 4 sectors -- financial, government, non-financial business, and households, contribute to rising overall debt.

Fiscal irresponsibility of the government is often matched by corporate and household irresponsibility, of further accumulating more debt. Having debt is normal, especially for investments or for emergency spending. But having an ever-rising debt is not normal, or not proper as the cost of their future payment becomes more and more difficult.

Fiscal irresponsibility 11: US debt default talks

(This is my article yesterday in thelobbyist.biz with original title, Fiscal irresponsibility and debt default)

The term “debt default” suddenly has become a common term in public discourse in the US. The biggest economy in the world, the strongest military power in the world, and among the beacons of the “rule of law” in the world, is entertaining the idea of violating the rule of law, by defaulting on its huge public debt payment. What happened?

It is actually common sense and will not take a degree in astrophysics or financial economics to understand that living beyond one’s means will bring someone to big trouble someday. By spending larger than one’s income or revenue, regularly and consistently, then one’s debt will simply pile up year after year. And that is what has happened to the US and so many other countries in the world now, rich and poor alike.

I will limit my words and show these charts and a table below to speak for themselves. These will help readers make their own conclusions too.

source: The Economist, Buy now, pay later, April 13th 2011 issue.

The US’ budget deficit (expenditures larger than revenues) from 2010 to 2012 is projected to average around 9 percent of GDP. This is a very high figure. The ballpark “sustainable” level is 3 percent of GDP or lower. I discussed this chart earlier in ATR and the soul of limited government.

Fiscal irresponsibility, of public spending larger than taxes and other revenues, has been around since the 70s or earlier. There was a short period of fiscal surplus in the last decade (mainly during Pres. Bill Clinton’s term) but were erased immediately. Source of this chart and below is The Economist, I just forgot to note the issue date.

While the US war in Afghanistan, Iraq and elsewhere, then the huge corporate bail-outs in 2009-2010 have contributed a large part for the big jump in public spending in recent years, it will be the expensive welfare and entitlement programs plus high interest payment that will tear down the American taxpayers’ and government’s pockets in the coming years and decades.

Recently, it was Ireland and Greece that experienced deep fiscal crisis. Soon, Portugal, Spain, Italy, UK and other European countries, and the US, will follow suit. Note the 14 countries above which have gross debt of 77 percent of GDP or higher in 2010.

The US, or any other highly indebted economies around the world, should NOT default on their debt payment. The current high debt payment is penalty for past wastes and excesses. It should be a painful reminder that fiscal irresponsibility is wrong.

What the US and other highly indebted countries should DO, is to cut spending, from the size of their bureaucracy to military spending to expensive entitlements to foreign aid. If revenues are not sufficient to cover whatever bleeding heart programs, then that’s it. Governments should learn to live within their means.
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Five years ago, I wrote this:

How Bloated is the US Government?

MAY 08, 2006

The US has the largest economy in the world.
But it also is the most indebted country in the world.
And it has the biggest government spending, the biggest bureaucracy, in the world.
Just how big are the spending, and the taxes and borrowings to keep those huge expenditures?

Lucky that I checked the Mackinac website, and I saw Mr. Mark Brandly's article, "How big is Bush' big government?". For brevity purposes, I removed certain paragraphs; if interested to see the whole paper, please see http://www.mackinac.org/article.aspx?ID=7689

Below are the relevant numbers from Mr. Brandly's paper:

* Federal spending alone in fiscal year 2006 is expected to be over $2.7 trillion, which means the federal government spends $7.4 billion a day or $5.1 million in every minute of the year. This is 815 times the level of federal spending in 1930.

* This $2.7 trillion in federal spending breaks down to $9,000 per capita or more than $36,000 for the average family of four. If we add in all state and local spending, then total government depredations (a term Murray Rothbard used to describe the greater of government spending and government receipts) are currently over $4.4 trillion or about $14,700 per person annually.
* A significant portion of this spending is being financed with government borrowing. In 1930, the per capita debt load was $140 per person. The current federal total debt level is $8.4 trillion, which works out to around $28,000 per person. In short, the per capita debt load is 200 times larger than it was in 1930. Adjusting for inflation, the real debt per capita is still over 16 times more than it was in 1930.

* Federal government debt increased $553 billion in fiscal year 2005 alone. That's more than $1.5 billion of additional debt per day and over $1 million of borrowing per minute for every minute of the year. The interest on the debt in 2005 was $352 billion or more than $1,100 for every man, woman and child in the country. These interest payments are roughly equal to 37 percent of federal income tax revenues.

* Much of this debt is owed to the Federal Reserve. U.S. taxpayers are on the hook for $758 billion of government securities that are held by the Fed. So, on average, every person in the country owes the Fed about $2,500.

* One way to see the harm of government intervention is to realize its effects on our standard of living. The depredations of the state reduce the incentives to be productive, destroy our capital base and have a negative effect on economic growth. From 1959 to 2005, adjusting the numbers using the implicit price deflator, real Gross Domestic Product increased an average of 3.37 percent annually.

* Consider the possibility that government interventions reduced real economic growth 1 percent annually during this time. If there had been an additional 1 percent per year economic growth since 1959, then real GDP would currently be 55 percent higher than it is. The 2005 GDP of $12.5 billion would have been $19.3 billion. The median family income is estimated to be $44,389. A proportionate increase in this statistic results in a median income of $68,800.

* In this scenario, a worker with a salary of $44,389 who is losing 35 percent of his salary to taxes has a tax liability of $15,536. After paying the various types of taxes he gets to keep only $28,853 of his salary. With the extra 1 percent growth per year since 1959, if that worker represented the average, his gross salary would be $68,800 and he would get to keep all of it.

* It is conceivable that the $4.4 trillion of annual depredations could have caused more than 1 percent annual damage to our economic growth since 1959. What are the implications of a 2 percent negative impact on GDP? If the absence of interventions had added an additional 2 percent annual growth, this would have resulted in 141 percent more output today. The 2005 GDP would have been over $30 trillion and the median family income would now be $107,000. The worker described above with the $44,389 gross salary and the $28,850 of after tax pay, would have an income of $107,000. The depredations have reduced his net income by 73 percent.

* Those of us making the case for liberty have logic, history and morality on our side. Government intervention is immoral and should be stopped for that reason alone. However, the economic costs of the intervention are also important. Part of the appeal of freedom is that it leads to tremendously higher standards of living and these numbers show that government interventions that cause seemingly small amounts of harm, over time, impoverish a society.
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See also:
Part 10, Rich countries' public debt, April 27, 2011
Part 9, ATR and the soul of limited government, April 26, 2011