Is the U.S. Insolvent?

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The national debt fascinates me because, as an intelligent and educated person, I really have a problem understanding whether or not it is a serious issue. Some people argue that, using certain metrics, we are on par with previous eras. Others argue that we are on the verge of collapse. I don't really know. Despite graduate level economics courses, and lots of reading on the subject, both arguments sound good to me. (That's why I'm always so stunned when politicians, who are extremely busy people, seem to think the answers are so simple). Now a new report has been release that, according to some people, says that the U.S. is insolvent.

The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our federal deficits alone now total more than 400% of GDP.

That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday (12/15/06), deep in the holiday season, with little fanfare. Sometimes I wonder why the Treasury Department doesn't just pay somebody to come in at 4:30 am Christmas morning to release the report. Additionally, I've yet to read a single account of this report in any of the major news media outlets but that is another matter.

I'm skeptical that the situation is so dire, because it seems to me that the market would have figured out we were on a path to destruction and penalized US investments more severely than they have. But on the flip side, if the US financials represented a publicly traded company, I would probably short the stock. If you have interesting links related to this issue, please leave them in the comments for me.

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  1. david foster's Gravatar Comment by david foster on December 19th, 2006 at 3:51 pm

    What matters with debt is not just the amount, but how the money is spent. For example, no one is greatly concerned that General Electric’s debt is much higher than it was 10 years ago–because people understand that the money raised was spent on productive assets. The same principle applies to government debt.

    Consider some of the government spending of the past–which was surely paid for in part by debt: improvements of navigable rivers, interstate highway system, Tennessee Valley Administration, the victory in WWII, the victory in the Cold War, the Veterans Bill. All of these things were probably well worth the debt incurred on their behalf.

    What worries me now is not so much the debt as the dysfunctionality of many of the progams for which the expenditures are being made, particularly K-12 education and much of higher education. But the harm would be equally great, and maybe greater, if these things were funded entirely by current taxes, without related debt.

  2. Mike's Gravatar Comment by Mike on December 19th, 2006 at 5:52 pm

    Rob,

    You’re more economically savvy than me, but the big problem in the report seems to be social insurance liabilities, which most of us know represent promises no past or present politician meant to keep. They just left the mess for someone else to deal with. Expect the civil war to start when permanently-entitled boomers get the bad news about not getting any more government checks in a few years.

    Mike

  3. bee's Gravatar Comment by bee on December 19th, 2006 at 9:50 pm

    The debate is waged in a manner that limits the use economic theory or reason.

    Let’s start with a “model” of the problem. If one assumea the government is like a corporation that assumes a debt load we can then trace under what circumstances they would go insolvant and the potential manner in which to manage debt. Companies assume debt because they beleive it can improve its present and future prospects with such borrowing. A corporation will assume debt over an infinite horizon if the benefit is material. Unlike a person a corporation or government does not need to zero its balance because of death. Legal entities like corporations and governments have near infinite time horizons. Thus some of the work that assumes that the balance must be paid off at some future point in time are making an inappropriate assumption.

    Next we need to understand that to manage debt the economy must gorw faster than the debt rate. This is critical. We currently exist in such an environment. We will close our budget deficit by Nov 2008 at the current run rate. The key is economic growth. Without growth the debt will consume us.

    Next many of those forecasting insolvancy fail to compare our prospects with most nations in Europe or Japan. If we are in dire straights, where are they. I know this is not much of an argument. As a matter of fact it is a terrible arguement. I raise it only for context. I would welcome them to say that we are all doomed. This would permit many to see that the discussion is being dominated by those who like doom and gloom.

  4. bee's Gravatar Comment by bee on December 19th, 2006 at 9:52 pm

    The debate is waged in a manner that limits the use economic theory or reason.

    Let’s start with a “model” of the problem. If one assumes the government is like a corporation that assumes a debt load we can then trace under what circumstances they would go insolvant and the potential manner in which to manage debt. Companies assume debt because they beleive it can improve its present and future prospects with such borrowing. A corporation will assume debt over an infinite horizon if the benefit is material. Unlike a person a corporation or government does not need to zero its balance because of death. Legal entities like corporations and governments have near infinite time horizons. Thus some of the work that assumes that the balance must be paid off at some future point in time are making an inappropriate assumption.

    Next we need to understand that to manage debt the economy must grow faster than the debt rate. This is critical. We currently exist in such an environment. We will close our budget deficit by Nov 2008 at the current run rate. The key is economic growth. Without growth the debt will consume us.

    Next many of those forecasting insolvancy fail to compare our prospects with most nations in Europe or Japan. If we are in dire straights, where are they. I know this is not much of an argument. As a matter of fact it is a terrible arguement. I raise it only for context. I would welcome them to say that we are all doomed. This would permit many to see that the discussion is being dominated by those who like doom and gloom.

  5. bee's Gravatar Comment by bee on December 19th, 2006 at 9:54 pm

    I agree. The debate is waged in a manner that limits the use economic theory or reason.

    Let’s start with a “model” of the problem. If one assumes the government is like a corporation that assumes a debt load we can then trace under what circumstances they would go insolvent and the potential manner in which to manage debt. Companies assume debt because they believe it can improve its present and future prospects with such borrowing. A corporation will assume debt over an infinite horizon if the benefit is material. Unlike a person a corporation or government does not need to zero its balance because of death. Legal entities like corporations and governments have near infinite time horizons. Thus some of the work that assumes that the balance must be paid off at some future point in time are making an inappropriate assumption.

    Next we need to understand that to manage debt the economy must grow faster than the debt rate. This is critical. We currently exist in such an environment. We will close our budget deficit by Nov 2008 at the current run rate. The key is economic growth. Without growth the debt will consume us.

    Next many of those forecasting insolvency fail to compare our prospects with most nations in Europe or Japan. If we are in dire straights, where are they. I know this is not much of an argument. As a matter of fact it is a terrible argument. I raise it only for context. I would welcome them to say that we are all doomed. This would permit many to see that the discussion is being dominated by those who like doom and gloom.

  6. Bob's Gravatar Comment by Bob on December 20th, 2006 at 6:57 am

    Go visit a former Fortune 50 exec at
    http://www.optimist123.com Great site, IMO.

    Poke around. Steve is a growth proponent and converted me over from following the Concord Coalition and their doomsday message.

    It is not possible for the country to become insolvent as a corporation would. The worst outcome is hyper inflation.

  7. Ivan's Gravatar Comment by Ivan on December 20th, 2006 at 11:59 am

    Difficult question, because not only is the US unlike a corporation, but it’s currency is also the backbone of the financial world. In this sense, the US has never been “solvent”, dollars are only worth people’s trust in us. Fortunately, we’ve been pretty trustworthy. Unfortunately, if that trust does evaporate, bye bye dollar.

    “The worst outcome is hyper inflation”

    That’s pretty bad right there…

  8. Rob's Gravatar Comment by Rob on December 20th, 2006 at 1:23 pm

    David,
    Interesting point, but I doubt you could get many politicians to view it that way.

  9. Lord's Gravatar Comment by Lord on December 20th, 2006 at 1:28 pm

    With real interest rates still near all time lows, the economy is saying this is the time to borrow still more. The difficulty is finding productive uses for that borrowing.

  10. Bob's Gravatar Comment by Bob on December 20th, 2006 at 5:17 pm

    Ivan,

    My point is that there is no such thing as bankruptcy or insolvency for the US government. Of course hyper inflation is terrible though very unlikely. If things were so bad why is the 10 year treasury under 5%?

    Best to focus on growing the economy rather than a hunker down, all is lost position that the tabloid media and the left want you to do. If we can’t get pass the hysteria and get on with living and growing we are indeed doomed.

  11. James Altucher's Gravatar Comment by James Altucher on December 23rd, 2006 at 9:09 am

    It doesn’t seem like the numbers you quoted are so bad at all. Lets say make $100K a year (your “GDP”) and your debt is $400K and your interest payments are, on average, 5%. So out of your 100k you make you need to pay 20k. Big deal. This is completely ignoring that you might have substantial asset coverage as well.

    And its ignoring the fact that US economy is always growing and the global economy is growing even faster now (so, with a weaker dollar, and growing numbers of new consumers, we’ll have more customers).

    Enjoy the holidays and don’t let this report get you glum.

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