|Official government data are frightening – despite being wildly optimistic.|
Spending Crisis – Part II
Analyzing the Data
By: George Noga – May 5, 2019
This is the second of four posts on the spending crisis. The entire series is available on our website: www.mllg.us. Parts III and IV will be distributed on May 12 and 19 respectively. We begin with some data. The current public debt to GDP ratio is 78% and is increasing rapidly. GDP has been growing at 2.5% (with no recessions); we assume it continues to grow at 2.5% in the future, but at a net rate of 2.0% after taking into account the inevitable periodic recessions. The debt is now growing at 5.25%; we assume it grows at 6% until 2025, 8% to 2028 and 10% thereafter – again net of recessions. This assumption is consistent with projected deficits and demographics. These are conservative assumptions and actual results are likely to be worse.
Based on the assumptions supra, the US will exceed a 90% ratio in 2022 and a 100% ratio in 2025. After 2025 it gets really ugly, with the ratio approaching 150% by 2030. Social Security is now devouring its reserves, Medicare exceeds its funding in a few years and interest on the debt skyrockets. Deficits will average $1.5 trillion over the coming decade. The deficit easily will exceed $2 trillion during the next recession and it would not be shocking for it to be as high as $2.5 trillion, or even $3.0 trillion.
The really bad news is that the above data (mostly from government sources) are wildly optimistic. For example, CBO projected in 2018 that the deficit would not go above $1 trillion until 2022, but now is expected to exceed that in FY 2019-2020. CBO is touted as being non-political, but it really isn’t; it is required to follow the rules established by Congress. Hence, CBO is severely constrained and its data are neither objective nor accurate. MLLG’s data have proven to be far more accurate.
Caution: Don’t get hung up on the source of the numbers or the specific timing. There is no significant difference whether you use CBO, MLLG or other data; they all lead to the same ultimate outcome, only the timing differs slightly.
Significance of a 90% Public Debt to GDP Ratio
The 90% ratio is not arbitrarily plucked from the ether. Governments have been borrowing money for 600 years and there is no example of recovery from a 90% ratio without social and economic upheaval, usually accompanied by a lost generation until excess debt is purged. The 90% ratio is valid because beyond 90% the mathematics of interest and compounding results in an economic death spiral. Note: The World Bank asserts the tipping point is reached at 77%, which the US already has exceeded.
The crisis doesn’t begin on cue when the debt ratio hits 90%; that just represents the point-of-no-return. The crisis may not begin until years later when the ratio reaches 125%, or even higher. The 90% ratio is analogous to Titanic hitting the iceberg. The ship remained afloat for quite some time after the iceberg encounter and no crisis was immediately evident to passengers. Nonetheless, the moment Titanic hit the iceberg its fate was irreversible as is a nation’s fate once its debt exceeds 90% of its GDP.
The Mathematics of a 100% Public Debt to GDP Ratio
When GDP and the debt are equal, i.e. the ratio is 100%, it is much easier to grasp the mathematics of the death spiral. At a 100% ratio, the economy (GDP) must grow as fast as the debt to prevent a meltdown. Herein we assume that GDP grows at a sustained 2% rate net of recessions and in 2025 debt grows at 8%. The differential between the growth of the economy and the debt is then 6% per year; debt grows $2.0 trillion while GDP grows $400 billion. The annual addition to the debt now is up to $2.0 trillion and increasing; soon thereafter, the debt reaches critical mass.
Clearly, our debt is growing at a much faster rate than our means to discharge it. This is readily apparent to creditors who are likely to demand much higher interest rates. If interest on the debt simply reverted to its historic level of a composite 6%, it would amount to $1.5 trillion a year in 2025, equal to about 25% of the budget. Long before America reaches that point, the spending crisis will be in full bloom.
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Next on May 12th – Part III: Possible solutions to the spending crisis.