Biden’s $6.9 Trillion Deficit Gamble
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Reducing the deficit does not reduce the debt. You need a negative deficit (surplus) to do that. U.S. debt is projected to grow from $31 trillion to $50 trillion in 2033. Interest on the debt could grow from $500 billion to $3 trillion, which is about 60% of current tax revenue.
Deficits, debt, interest rates and inflation are intertwined and sometimes confused. For example, many believe that our deficit is our Debt. It’s not. In the following, I provide the arithmetic to tie these four economic factors together.
President Biden has proposed a $6.9 trillion budget that calls for reducing deficits and raising taxes on wealthy people and large corporations. There is a lot of spending in this budget that fuels inflation. The planned $1 trillion reduction in the deficit does not reduce the debt. The Congressional Budget Office projects the U.S. debt to grow from $31 trillion today to $50 trillion in 10 years.
Debt is accumulated deficits
Here’s the arithmetic: Debt = ∑ Deficits = $31 trillion currently
President Biden proudly brags about his accomplishment of reducing the federal deficit by more than $1 trillion. Reducing the deficit is indeed praiseworthy. What exactly did President Biden do?
A close look reveals that the deficit increased a lot in 2020 and 2021 due to $5 trillion in COVID spending. Then, in 2022, not much was spent on COVID, so the deficit decreased. In other words, the president had little to do with the decrease in the deficit.
Many hear the decrease in the deficit as a reduction in the national debt, but that’s far from the truth. Although the deficit declined in 2022, the national debt continued its monumental climb above $30 trillion.
In economic terms, the deficit is a “flow” variable, and the national debt is a “stock” variable. The debt is the accumulation of the historical deficits.
There should be a big concern about the “off-balance-sheet debt” for Social Security and Medicare, estimated by Professor Lawrence Kotlikoff to exceed $75 trillion. We don’t see this debt in official reports because it is not yet in our deficit, but it will be. Kotlikoff’s $75 trillion is the present value of future payments not covered by taxes.
All-in Debt = ∑Past Deficits + Present Value of Future Net Payments for Medicare and Social Security
= $30 trillion + $75 trillion = $105 trillion
That’s more than four times current GDP.
The president reaffirmed his intention to reject any cuts to Social Security or Medicare benefits and said he would work with Congress to shore up these programs. But he has no specific plan.
Interest on the debt as a percent of tax revenues
Federal revenues in 2022 were approximately $5 trillion, which is 20% of GDP. Interest expense was $500 billion, so interest on the $30 trillion debt was about 1.7% of GDP. This interest rate is low because the government has been executing a zero interest rate policy (ZIRP).
Left unmanipulated, interest rates have averaged 3% above the rate of inflation, so 9.5% in the current 6.5% inflationary environment. If Federal Reserve tapering allows interest rates to increase to their historic level of 9.5%, interest on $30 trillion will be about $3 trillion which is 60% of tax revenues, dwarfing other expenditures as shown in the following summary of current spending.
Inflation and the debt spiral
The U.S. government cannot renege on its promise to repay principal, but it can and has reduced its interest payment on that debt through its ZIRP. But ZIRP requires money printing that the Federal Reserve uses to overpay for bonds, thereby keeping interest rates low. The Fed cannot simultaneously fight inflation and execute ZIRP.
The other way to pay for the debt is to print more money, called “monetizing.” This creates a debt spiral because money is “printed” when the Treasury issues new bonds. Most of those bonds are being bought by the Federal Reserve. As debt increases, interest on that debt also increases, creating a debt spiral.
Investors are routinely gaslighted by Wall Street and Pennsylvania Avenue. The arithmetic of economic threats to the economy is straightforward but rarely discussed. “Raising the debt ceiling” is a case on point. We all expect it to increase without a serious discussion of federal spending and the promises for Social Security and Medicare.
It was painfully obvious in the President’s State of the Union Address that addressing the liabilities for Social Security and Medicare is not on the table, so the deficit will continue to escalate, leading to future increases in the debt ceiling, until the gears of the economy lock once again as they did in 2008. But this time quantitative easing will not bail us out. That’s just simple arithmetic.
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