On Deficits And Debt-Financed Government

On Deficits And Debt-Financed Government

Posted by Karl Denninger

The latest estimate is now out from the CBO, and is the usual practice, the deficit number keeps getting bigger:

President Obama’s fiscal 2011 budget will generate nearly $10 trillion in cumulative budget deficits over the next 10 years, $1.2 trillion more than the administration projected, and raise the federal debt to 90 percent of the nation’s economic output by 2020, the Congressional Budget Office reported Thursday.

Note that the CBO also estimates that GDP will climb to $22.5 trillion (from $14 trillion today); a compound growth rate of 5%.  This is approximately the rate at which GDP has grown from 2000 onward but ignores the trend, which has been downward since the 1950s.

From the 1950s onward the compound growth rate of GDP is 6.81%.  But from 1990 onward it is only 5.39%, and from 2000 onward 5.19%.


The decreasing marginal productivity of new debt issuance.

There is a good argument to be made that we are now in a place where we are getting negative GDP contribution from new debt issuance, as I have written on before

IF this chart is accurate, then the gambit of politicians – that they will all be out of office before this blows sky-high (on the back of your children and grandchildren) will be proved inaccurate.

It will, in fact, blow up in their face – that is, they will not escape the consequence of their actions.

Worse, those consequences will not be simply political defeat, because the outcome will be the inability of The Federal Government to finance its operations.  You’re free to extrapolate “what comes next”; I can assure you it will not simply be peaceful acquiescence by the roughly 100 million Americans who will suddenly find that the government tit has run dry – without warning.

The warning shots on this were fired during Carter’s administration.  There was a crisis of confidence of sorts that forced rates much higher – Volcker followed with what he had to do, not what he wanted to do.  Contrary to popular belief The Fed didn’t “break the back of inflation”; the market demanded that the BS stop here and now, or what would stop was the government.

This time around we do not have the luxury of “simply” accepting much higher government borrowing costs.

To put this in context you can look at the interest expense of The Federal Government.  You will note that despite debt going up a lot in Fiscal 2009 the interest expense went down – a lot (about 15%.)  But this year interest expense, if it tracks the five months thus far in the books, will rise from $383 billion to $434 billion, a 13% increase – almost erasing the “gains” from the zero interest-rate policy.

On September 30th 2009 the outstanding debt was $11.909 trillion dollars.  That is an average interest coupon across the entire float of the public debt of 3.22%.

Now consider what happens if short rates go back to the 5% range – a historical reasonable point, and long rates go into the 7% range (a point that this chart’s inverted head-and-shoulders, by the way, says is likely within the next two years):

Assuming Treasury continues to try to shove toward the short end of the curve, a strategy that exposes it to extreme amounts of rollover risk, the average coupon would likely rise to about 5.5%.

This would drive interest expense to $780 billion by September 2011.

Note that if historical averages hold, Treasury would take in roughly $1.2 trillion in personal income taxes.  Interest expense would rise to consume approximately 2/3rds of that amount.

Let’s further consider that interest expense would be about 80% of the entire budget deficit of fiscal 2011.

Two questions immediately arise from this data:

  1. Do our Congressfolk (and the Administration) really think they will expire of natural causes before the spiral that, on the present path, will come, appears and those 100 million angry and (more importantly) hungry Americans decide to issue them an invitation to dinner?

  2. Why are we debt-financing our government in the first place?  Adding up the interest paid from 1988 to 2009 we find that $7.34 trillion of the $11.909 trillion, or sixty one percent, of our “debt” exists as a consequence of paying interest to private parties and foreign governments

Consider the alternative.  We have a $4.57 trillion “deficit” between interest and debt looking only at 1988 – 2009.

But from 1988 – 2009 we produced (GDP) approximately $210 trillion in net output.

We currently finance our “excess spending” through debt issuance. 

What would happen if we instead decided to issue non-debt-backed currency from the Treasury directly into the economy?

That is, instead of selling Treasuries, what instead Treasury was to simply print dollars (backed by nothing more than Treasury’s ability to tax down the road) and thus paid zero interest?

Well, that’s easy to figure out.  Since issuing currency is the definition of monetary inflation we can trivially compute the inflationary impact of printing the required $4.57 trillion in money to close the gap – in other words, for Treasury to simply issue and spend in the economy the net $4.57 trillion the government has instead paid in interest from the years 1988 to 2009.

The inflationary impact is 210 / 4.57 = or….

2.18% – and not per year either.  Rather, that’s the total inflation as a consequence of this policy over the entire 22 year period of time!

Why is it that we are allowing debt merchants to “finance” our deficits? 

We can stop this idiocy now, before it spirals out of control – and spiral out of control it will.  It is highly unlikely that the current path will be able to be maintained until our children and grandchildren get the bill – rather, odds are that it will detonate within the next five years, resulting in the destruction of our society, political system, and civil order.

Or we can tell the debt merchants – that is, the banks – to get stuffed, and that we will not pay the so-called “existing debt.”  They will, in turn tell us they won’t buy any future debt.  We simply reply that we don’t care, since we have another option – the spending of deficit dollars directly into the economy without issuing debt!

Yes, managed improperly such a path runs the risk of a hyperinflationary debacle similar to Weimar or Zimbabwe.  But as you can see from the above even with the profligacy of the last 22 years, including the wars in Iraq and Afghanistan, the net total inflationary impact over that entire period, had we done this for the 22 years previous, would be slightly more than 2% – over the entire 22 year period, or less than 0.1% annually.

There are transition details that I will outline in future Tickers, and I assure you that the “debt merchants” (banks, including foreign central banks) will not like the implications of same.

But this does not change the math or choice – our politicians can  choose between this path forward or they can choose to take the risk of literally being dinner at the table of 100 million angry and hungry Americans.

Choose wisely.