2009 August 09 Sunday
Odds Of Eventual US Sovereign Debt Default?

Jeffrey Rogers Hummel, an economist at San Jose State U in Silicon Valley, says eventual US federal default on sovereign debt seems likely.

What about increasing the proceeds from explicit taxes? Examine Graph 1, which depicts both federal outlays and receipts as a percent of GDP from 1940 to 2008. Two things stand out. First is the striking behavior of federal tax revenue since the Korean War. Displaying less volatility than expenditures, it has bumped up against 20 percent of GDP for well over half a century. That is quite an astonishing statistic when you think about all the changes in the tax code over the intervening years. Tax rates go up, tax rates go down, and the total bite out of the economy remains relatively constant. This suggests that 20 percent is some kind of structural-political limit for federal taxes in the United States. It also means that variations in the deficit resulted mainly from changes in spending rather than from changes in taxes. The second fact that stands out in the graph is that federal tax revenue at the height of World War II never quite reached 24 percent of GDP. That represents the all-time high in U.S. history, should even the 20-percent-of-GDP post-war barrier prove breachable.2

The point about historical tax revenue as a percentage of GDP seems persuasive. How many Americans are going to support cutting their own effective buying power by 20% to pay for US federal entitlements programs in the 2020s and 2030s? On the other hand, the people who want to get stuff from the government and the people who want them to get stuff from the government are substantial factions as well (with some considerable overlap with the people who do not want to be taxed).

Currently I see Obama doing something that is the mirror image of what Reagan tried to do. Reagan tried to cut taxes to starve government and cut its size. Obama is trying to so increase spending that taxes have to rise to support the spending programs. Once the spending programs get established they develop powerful constituencies to defend them. If Obama can enact more new spending programs he increases the odds of a call for a tax increase as the needed fiscal response.

But the problem is that government is already on an unsustainable course with growth in entitlements spending before considering new Obama entitlements such as medical insurance funded by government.

Compare these percentages with that of President Barack Obama's first budget, which is slated to come in at above 28 percent of GDP. Although this spending surge is supposed to be significantly reversed when the recession is over, the administration's own estimates have federal outlays never falling below 22 percent of GDP. And that is before the Social Security and Medicare increases really kick in. In its latest long-term budget scenarios, the Congressional Budget Office (CBO), not known for undue pessimism, projects that total federal spending will rise over the next 75 years to as much as 35 percent of GDP, not counting any interest on the accumulating debt, which critically varies with how fast tax revenues rise. However, the CBO's highest projection for tax revenue over the same span reaches a mere 26 percent of GDP. Notice how even that "optimistic" projection assumes that Americans will put up with, on a regular peacetime basis, a higher level of federal taxation than they briefly endured during the widely perceived national emergency of the Second World War. Moreover, once you add in the interest on the growing debt because of the persistent deficits, federal expenditures in 2083, according to the CBO, could range anywhere between 44 and 75 percent of GDP.3

I see about 4 possible resolutions of the coming financial crisis:

  • US government default. This seems like the lowest probability outcome.
  • Huge tax revenue increase. Only one way to do that: Stiff European-style Value Added Tax (VAT) that raises prices 10-20-30%. Goods and services become as expense as we see in Europe. We get a permanent large European-style welfare state but with a worse outcome. I see the people who support this as enemies.
  • Inflation. This might happen thru the back door as a response to a financial crisis even bigger than what we saw last fall. The Federal Reserve's attempt to stop a panic will lead to an even bigger monetary injection than we've seen in the last year.
  • Massive cuts in entitlements programs. California's fiscal crisis provides a demonstration.

If and when the US dollar ceases to be the world's reserve currency a sharp transition caused by large scale flight from the dollar could cause skyrocketing interest rates and a downturn that causes one or more of the above resolutions. We might get some combination of the latter 3 possibilities in a series of crises with different levels of contribution from each item.

The biggest mistake the Democrats are making is to assume economic growth will fund their dreams. I see demographic problems slowing economic growth as a lower skilled work force grows up to replace the smarter Baby Boomers. Also, Peak Oil is coming at most 11 years from now and possibly much sooner. Economist James Hamilton has explained in his paper Causes and Consequences of the Oil Shock of 2007-08 how oil price run-ups cause recessions. Well, our current recession is basically a rehearsal for worse recessions to come in the 2010s as a result of high oil prices. The money isn't going to be there to make the government spending scenarios above remotely possible.

As people get poorer due to Peak Oil and demographic problems they will become more opposed to taxes on what remains of their take-home income. So I'm expecting some really severe cuts in entitlements. Expect to work longer. Expect more entitlements for old folks to become needs tested. Save now because you are going to need the money in years to come.

Share |      By Randall Parker at 2009 August 09 05:49 PM  Economics Government Costs


Comments
Clarium said at August 9, 2009 7:07 PM:

There is going to be no work and no "labor market political activities." What countries (besides those with oil) will to relatively well during peak oil?

Clarium said at August 9, 2009 7:15 PM:

"Huge tax revenue increase. Only one way to do that: Stiff European-style Value Added Tax (VAT) that raises prices 10-20-30%. Goods and services become as expense as we see in Europe. We get a permanent large European-style welfare state but with a worse outcome. I see the people who support this as enemies"

We are enemies Randall. But what do you option do you pick? I choose that. How would it be worse than Europe? For one, it doesn't seem likely that there will be any "labor market political activities." Furthermore, I suppose you will say a dumber population makes it worse. At least the people in Europe do not have supposed low IQ people. Will the VATs be in the form of tariffs. At least it will reduce foreign consumption and reduce the trade deficit.

But, Randall, instead of being enemies, we should be allies. I do not support the influx of third world immigration as that destroys social capital.

dymphna said at August 9, 2009 7:34 PM:

It's too late to fix anything. We didn't produce the children who would replace us in sufficient numbers to even begin to break even.

I hope there is means-tested old age pensions, but I see no pensions at all. The government waited too long to fix that Ponzi scheme and Obama wants to add a pox of spending on top of it. The man is mad.

Lots of people starting gardens, erecting clotheslines, making do and going without. Those with jobs feel grateful to be employed but wonder how long it will last...

We will return to a monotonous diet and a poorer, shorter existence. Not today, not next year. But it's coming. For the very young, it won't be a hardship. Just as children born to the nouveau riche take their luxurious surroundings for granted, children coming along with take their parent's straitened circumstances in stride.

What is of concern is whether the currently marriageable, fecund generation will think they're too poor to bring forth children. Just like the boomers were too busy to do so in sufficient numbers.

Third world immigration may arrive whether we like it or not. The Japanese know that: who else will take care of them when they are old??

Randall Parker said at August 9, 2009 7:43 PM:

dymphna,

The Japanese are deporting immigrants, both legal and illegal. They see the recession as an occasion to kick out foreigners to save jobs for Japanese. They are so unlike us and so much more practical.

Pensions: Yes, big delays. I expect means testing.

My advice: work harder. Save more. Find ways to make more money and raise your income.

I think one can protect one's assets if inflation starts becoming a serious threat. Invest in stocks of foreign companies that have valuable commodities in the ground.

Stephen said at August 9, 2009 8:23 PM:

Randall said: I see about 4 possible resolutions of the coming financial crisis...

There is a fifth option: How about cutting defense spending by, say, 60%? That would save you $400 billion a year and you'd still be the country spending the most on weapons.

Clarium said at August 9, 2009 8:23 PM:

Randall, what odds do you place on a Japanese, Italian, or British sovereign default? Those countries seem to have worse balance sheets.

Francis said at August 9, 2009 8:52 PM:

Three G's: Gold, guns and groceries. Better find a nice, white rural area to live in.

Wolf-Dog said at August 9, 2009 9:16 PM:

Clarium:

Japan has an accumulated surplus as far as international trade balance is concerned (although this can easily turn into a trade deficit if the US stops its trade deficit with Japan), and so Japan is currently in a less precarious situation than the US.

Stephen:

If the US cuts deficit spending by 60 % then this will be anti-Keynesian action because even though only about 5 % of the GDP is military, I have read that nearly 10 % of the jobs depend on the defense industry. Surely the defense jobs can gradually be converted into manufacturing jobs that are economically more ordinary, but this will take time.

But the 5th alternative is to stop the foreign trade deficit of over $600 billion, and this would generate a lot more income internally, a lot more jobs, less poverty. Already a lot of Americans are so poor that they would work at wages comparable to Chinese workers.

Randall Parker said at August 9, 2009 9:38 PM:

Stephen,

3% of GDP? That's supposed to solve the problem? Did you see the numbers above? We are talking about a more than doubling of the US federal government's spending as a percentage of GDP.

Grim said at August 9, 2009 11:47 PM:

Stephen has a good point. Obama and the dems hate the military and would love to gut our defense industries. They can gut 90% of research and new products and get rid of 75% of the ground forces. They can then replace the missing ground pounders with Obama's youth army he campaigned on. All those white republican voters would be out of work and Obama would have an army loyal to him. Would be a very smart move.

Truth(er) said at August 10, 2009 12:11 AM:

"There is a fifth option: How about cutting defense spending by, say, 60%? That would save you $400 billion a year and you'd still be the country spending the most on weapons."

There is no saving money by cutting defense. That means those who work in defense industries become unemployed.

Mthson said at August 10, 2009 5:22 AM:

"There is no saving money by cutting defense. That means those who work in defense industries become unemployed."

This sounds basically like the 'pay people to dig holes and then fill them in' argument. Shifting the economy away from labor that doesn't benefit society to labor that does increases society's wealth.

Put the scientific geniuses working in the defense industry to work in physics and medicine and everybody benefits. Not dying of curable diseases would be much more valuable to us than maintaining self-perpetuating military bases everywhere in the world.

dchamil said at August 10, 2009 6:52 AM:

Another resolution of the crisis is a forced refunding of the federal debt, which is a concealed default. Friday evening you owned a 6-month treasury bill. Come Monday morning, you own a perpetual bond yielding one percent. Perpetual bonds are never redeemed for cash.

Yet another resolution of the crisis is federal takeover of private pension plans, followed by looting of those plans. This has in fact been done not long ago in Argentina.

Nobody said at August 10, 2009 7:29 PM:

"They can then replace the missing ground pounders with Obama's youth army he campaigned on. All those white republican voters would be out of work and Obama would have an army loyal to him. Would be a very smart move."

It is about time somebody other than rural and ethnic whites get shot dead or blown up in some shithole. I endorse this plan! And also seriously, having lots of unemployed whites around is very dangerous for liberals and NAM lackeys. Think about it. Now if the Obama Army was to be deployed domestically, they could also be called targets. That shit might fly in liberal dumps like NYC or DC, but probably not in Kansas.

Francis said at August 10, 2009 7:33 PM:

Yet another resolution of the crisis is federal takeover of private pension plans, followed by looting of those plans. This has in fact been done not long ago in Argentina.

Count on it:

http://www.usnews.com/blogs/capital-commerce/2008/10/23/would-obama-dems-kill-401k-plans.html

Like I said, gold, guns and groceries...


Cleanthesbrule said at August 12, 2009 8:02 PM:

There is a fifth option: How about cutting defense spending by, say, 60%? That would save you $400 billion a year and you'd still be the country spending the most on weapons.

This wouldn't save enough, but it does bring up a sixth option. Increase defense spending, reimpose conscription, find a likely excuse and invade and kill a bunch of useless foreigners who now own US debt obligations. In the two world wars the USA defaulted on debts owed to enemy countries, of course. Make Japan and China enemies and all their US dollar holdings go to zero value.

Engineer-Poet said at August 13, 2009 10:55 AM:

If private ownership of gold is outlawed again, what's left?

China seems to be on a push to convert its treasuries into hard assets, like oil and minerals.  Are we going to declare war against Angola or Uganda to cancel the bonds they hold?  Not going to happen; we'll harass the Chinese by stoking insurgent movements of the dispossessed natives while inflating the debt away.

What we really need to do is put our unemployed to work.  I suggest deporting all our illegal immigrants and putting the inner-city welfare recipients into the ag and meatpacking jobs they currently hold.  Ag labor should be among the list of punishments for e.g. non-support of children born out of wedlock.

In one stroke, one major criminal class would be sent out of the country and another would be too busy to commit crime.  Enormous expenses for ESL, incarceration of illegals, and so forth would disappear.  It strikes the deficit where it lives.


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