Why is US Federal government debt so important?

When governments go into debt, they are essentially borrowing money from the marketplace to cover their costs. Governments, like businesses and households, often spend more than they gain in revenue. In order to the cash flowing, money has to be borrowed.

Keynesian fiscal policy worked out that government fiscal policy should be completely neutral over the course of the business cycle. In practice, this meant that government could (and should) run fiscal deficits during times of economic hardship, while also running fiscal surpluses when things are good. Overall, though, governments should balance their books.

The problem with this sort of activity is that governments have found it easy to run long term deficits. It is easy for governments to cut taxes and/or increase spending. It is harder for them to increase taxes and/or reduce spending. The reason for this is political - those in power want to please the electorate rather than being fiscally responsible.

Long term and growing government deficits are, however, a source of great hardship to the countries that run them. Countries which are suffering from large net debt include Japan, Jamaica, Belgium and Italy. In the case of these countries, net government debt runs to around 100% of GDP or more.

Imagine you had a credit card in which you owed more than you brought home in a year. If you earn, say, $50,000 in a year, imagine having a $50,000 credit card debt.

The United States is hardly at the debt levels of the countries I have mentioned - but it is getting there. The CIA World factbook has it at around 36.8% of GDP (2007 est.), but other sources indicate that it has exceeded 60% of GDP.

The problem is that when deficits get out of control, interest payments on debt can quickly begin to dominate government spending. According to this website, the Federal government spends nearly $700 billion in health costs (2007) and nearly $600 billion on defence. The next highest is the Department of Agriculture, which is below $100 billion. Other spending includes the department of education at around $61 billion and NASA at $15 billion.

So how much does the US Federal Government pay in interest charges on money that is has borrowed over the years? Well, according to the latest figures, the amount of interest paid in 2007 was $429,977,998,108.20. Or, put simply:

$430 billion

in interest payments alone

in 2007

Now I don't know about you, but when NASA gets $15 billion and education gets $61 billion, that interest bill looks big, and it is.

Think about what might have happened had the US Federal government been fiscally responsible for the past 25 years. Imagine if net debt was negligible or even zero. It would mean that that $430 billion could have gone in tax cuts or spending increases over time.

US GDP in 2007 was $13.75 Trillion. The amount of money the US government is paying back in interest represents 3.13% of GDP. US Agriculture represents 1% of GDP. Debt repayment is over three times the size of the Agricultural sector!

When a business a household or a government chooses to run up massive amounts of debt, they are using the future to pay off the present. But the higher the debt gets, the more it damages the future. Some belt tightening must occur - which is always going to be hard on the present - or else borrowing money will become harder. In the case of governments who run massive public debt, the effects will be higher market interest rates.

In 2005 I predicted very hard times ahead for the US economy. I predicted that a combination of Peak Oil, a housing market downturn, a large current account deficit and increasing US Federal debt will produce a "perfect storm" that is likely to damage the US economy for years to come. The housing market has definitely imploded, Peak Oil is driving oil prices back up above $100 per barrel again and the large current account deficit has helped the US Dollar scrape the bottom of its historical value. But when you also consider that one of the US government's largest expenses, after health and defence, is paying back interest equivalent to over 3% of GDP, you have to wonder how bad things are going to get.

© 2008 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/

FAQ about the author

Creative Commons License

This work is licensed under a
Creative Commons Attribution 3.0 License.

1 comment:

BLBeamer said...

I generally agree, but I might quibble as to whether or not the US housing market has imploded. Certain cities and segments have serious problems, but in my county, for example, average prices have only retreated about 4% from last year, and last year was an all time high.

So, to say the entire market has imploded is a bit hyperbolic. Two of my brothers sell residential real estate. Both say that the very high "super loans" have dried up and loans for those who had no business getting a mortgage in the first place have disappeared, as well as the shady brokers who serviced them.