Deepening Debt

December 2, 2018

by Steve Stofka

Each time the Federal Reserve raises interest rates, the President tweets out his disapproval. This week Fed Chair Jerome Powell indicated that interest rates increases might be slowing and the Dow Jones average jumped up more than 2% in a few hours (Note #1). Presidents don’t like rising interest rates because they contribute to a slump in housing and car sales, two relatively small pieces of the economy that create ripples throughout a community’s economy. Trump’s strategy relies on strong growth.

The passage of the tax law last December reduced Federal tax revenues, which contributed to a rising deficit. The gamble was that the repatriation of corporate profits plus a reduced corporate tax rate would spur higher GDP growth which would offset the falling revenues. It hasn’t so far.

Let’s get away from dollars and use percentages. Economists track the annual budget deficit as a percent of GDP. I’ll call it DGDP. Let’s say a family made $50,000 last year and had to borrow $1000 because they spent more than they made, their DGDP would be $-1,000/$50,000 or -2%. In a growing economy, the DGDP rises, or gets less negative. It falls, or gets more negative, as the economy nears a recession.


A DGDP below the 60-year average of -2.5% indicates an unhealthy economy and, by this measure, the economy has not been healthy since 2007. The DGDP was the same in the last year of Bush’s presidency as it was in the last year of the Obama presidency. By 2014, it had risen above -3% and rose slightly again in 2015 but fell again the following year.

In 2016, the last year of the Obama presidency, the DGDP was -3.13%. In the first year of the Trump presidency it fell slightly to -3.4%. As I said earlier, the administration and Congressional Republicans hoped the tax law passed at the end of 2017 would spur enough GDP growth to offset declining corporate revenues. So far, that has not happened. The 2018 budget year just ended in September. Preliminary figures indicate that the deficit will be 3.9% of GDP this year (Note #2). Some economists project a DGDP near -5% in 2019.

Japan’s economy for the past two decades strongly suggests that an aging population weakens GDP growth. The U.S. economy must flourish against that demographic headwind. By December this year, Social Security (SS) benefits will surpass the $1 trillion mark, equal to or surpassing SS taxes collected (Note #3). For years, the excess in SS tax collections has lessened the amount that the Federal government had to borrow from the public. Each year, the government has left an I.O.U. in the SS trust fund. The total of those IOUs is almost $3 trillion.

Now the Federal government faces two challenges: interest on the ever-growing Federal debt and the government’s need to borrow more from the public to “pay back” those IOUs. The interest on the debt will soon overtake defense spending. Politicians could reduce cost of living increases in SS benefits by indexing benefits to the chained price index, a flexible measure of inflation that assumes that human beings alter their consumption in response to changing prices. Benefits are currently indexed to the Consumer Price Index (CPI) whose fixed basket of goods never changes. The CPI overstates inflation, but seniors are sure to lobby against any changes that would reduce cost of living increases. Politicians are reluctant to face angry seniors who might boot some of them out of office at the next election.

Trump has a better alternative than strategically lowering benefit increases for the swelling ranks of retiring Boomers – increase SS tax collections. The only way to do that is jobs, jobs, jobs. Jobs that are “on the books,” that take out SS taxes with each paycheck; not the jobs of the underground economy that flourish in immigrant communities. More jobs to draw in the half million discouraged workers who are sitting on the sidelines of the job market (Note #4).

Jobs, jobs and more jobs take care of a lot of budget problems. Campaign strategist James Carville stressed that point to Bill Clinton during the 1992 Presidential campaign. Higher interest rates hurt the construction, auto and retail industries, and blue collar small business service industries. All of these are more likely to reach out and hire marginal workers.

The headwinds are more than demographic. The economy has been stuck in low for a decade. In the eleven years since the 3rd quarter of 2007, just before the 2007-2009 recession, real GDP has averaged only 1.6% annual growth (Note #5). That is barely above population growth. Sectors that were strong, housing and auto sales, have slowed. Housing sales have declined for six months. Auto sales have declined for 18 months. Fed interest rate policy has been very supportive but that is slowly being withdrawn.

The DGDP is one more indicator that we should already be in a recession or approaching one. A recession will add to the demographic headwinds, increase the annual budget deficit and swell the accumulated federal debt. Job growth must counter job loss due to automation. Good policies are those likely to add jobs. Bad policies are those that thwart job growth. It doesn’t matter how well intentioned the policies are. Good or bad for job growth is all that matters in the next decade.

Here’s why. Another credit crisis is building. Low interest rates transferred billions of dollars in interest from the savings accounts of older people to businesses and government, who were able to go on a borrowing binge. Defaults and delinquency on business loans will probably be the source of our next crisis. After that is the coming pension crisis in several cities and states. Let’s hope those two don’t hit simultaneously.


  1. Within a day, interest rate futures that had priced in a 1/2% increase in the Fed Funds Rate during 2019 fell to just .3% for next year.
  2. Estimates of 2018 Fed deficit and GDP
  3. Social Security trustees’ summary report for fiscal year 2017.
  4. BLS series LNU05026645 discouraged workers. After ten long years, there are now as many discouraged workers as October 2008, just as the financial crisis sent the economy into shock. Within two years after the onset of the crisis, the number of discouraged workers had exploded 250%, reaching 1.25 million in October 2010.
  5. Real GDP: 3rd quarter 2007 – $15,667B. 3rd quarter 2018 – $18,672B. Constant 2012 dollars.

An Interest-ing Debt

February 12, 2017

Republicans used to talk about the country’s debt load but such talk is so inconvenient now that they control the House, Senate and Presidency. Perhaps it was never more than a political ploy, a rhetorical fencing. Now there is talk of tax cuts and more defense spending, and a $1 trillion dollar infrastructure spending bill. 48 states have submitted a list of over 900 “shovel-ready” projects.

House Speaker Paul Ryan used to be concerned about the country’s debt. Perhaps he has been reading that deficits don’t matter in Paul Krugman’s N.Y. Times op-ed column. For those of us burdened with common sense, debts of all kinds – even those of a strong sovereign government like the U.S. – do matter. The publicly held debt of the U.S. is now more than the country’s GDP.


In 2016, the Federal interest expense on the $20 trillion publicly held debt was $432 billion, an imputed interest rate of 2.1%. Central banks in the developed world have kept interest rates low, but even that artificially low amount represents 11% of total federal spending. (Treasury)  It represents almost all the money spent on Medicaid, and more than 6 times the cost of the food stamp program. (SNAP)

The latest projection from the CBO estimates that the interest expense will double in eight years, an annual increase of about 9%. The “cut spending” crowd in Washington will face off against the “raise taxes” faction at a time when a growing number of seniors are retiring and wanting the Social Security checks they have paid toward during their working years.

In the past twenty years the big shifts in federal spending as a percent of GDP are Social Security and the health care programs Medicare and Medicaid. These are not projections but historical data; a shift that the CBO anticipates will accelerate as the Boomer generation enters their senior years. Ten years ago, 6700 (see end of section)  people were reaching 65 each day. This year, over 9800 (originally 11,000, which is a projection for the year 2026) per day will cross that age threshold.

CBO Source

A graph of annual deficits and federal revenue shows the parallel paths that each take. The trend of the past two years is down, promising to accelerate the accumulation of debt.


More borrowing and higher interest expense each year will crowd out discretionary spending programs or force the scaling back of benefits under mandatory programs like Social Security, Medicare and Medicaid. President Trump can promise but it is up to Congress to do the hard shoveling.  They will have to bury the bodies of some special interests in order to get some reform done.

[And now for a bit of cheer.  Insert kitten video here.]

We already collect the 4th highest revenue in income taxes as a percent of GDP. Canada and Italy head the list at 14.5%.
South Africa 13.9%,
U.S. 12.0%,
Germany 11.3,
and France 10.9 all collect more than 10%. (WSJ) Those who already pay a high percentage in income taxes will lobby for a VAT tax to increase revenues. Income taxes are progressive and impact higher income households to a greater degree. Poorer households are more affected by a VAT tax.  Cue up more debate on what is a  “fair share.” Many European countries have a VAT tax and the list of exclusions to the tax are bitterly debated.

Adding even more social and financial pressure is the lower than projected returns earned by major pension funds like CALPERS. For decades, the funds assumed an 8% annual return to pay retirees benefits in the future. In the past ten years many have made 6% or less. Several years ago, CALPERS lowered the expected return to 7.5% and has recently announced that they will be gradually lowering that figure to 7%.

Each percentage point lower return equals more money that must be taken from state and local taxes and put into the pension fund to make up the difference. Afraid to call for higher taxes and lose their jobs, local politicians employ some creative accounting to avoid the expense of properly funding the pension obligations. In a 2010 report, Pew Charitable Trust analyzed the underfunding of many public pension funds like CALPERS and found a $1 trillion gap as of 2008. (Pew Report) The slow but steady recovery since then may have helped annual returns but the inevitable crisis is coming.

In December 2009, I first noted a Financial Times Future of Finance article which quoted Raymond Baer, chairman of Swiss private bank Julius Baer. He warned: “The world is creating the final big bubble. In five years’ time, we will pay the true price of this crisis.”
That warning is two years overdue. Sure hope he’s wrong but … here’s the global government debt clock. The total is approaching $70 trillion, $20 trillion of which belongs to the U.S.  We have less than 5% of the world’s population and almost 30% of the world’s government debt.  As Homer Simpson would exclaim, “Doh!”

Correction:  Posted figure for 10 years ago was originally 9000.  Current figure was originally posted at 11,000.  Projected for the year 2026 is 11,000.)


Market Valuation

Comments by President Trump indicating a “sooner than later” schedule for tax cuts helped lift the stock market by 1% for the week. The Shiller CAPE ratio currently stands at 28.7, just shy of the 30 reading on Black Tuesday 1929. (Graph) Since the average of this ratio is about 16, earnings have some catching up to do. Today’s reading is still a bargain compared to the 44 ratio at the height of the dot com boom. Still, the current ratio is the third highest valuation in the past century.

The Shiller Cyclically Adjusted Price Earnings (CAPE) ratio
1) averages the past ten years of inflation adjusted earnings, then
2) divides that figure into the current price of the SP500 to
3) get a P/E ratio that is a broader time sample than the conventional P/E ratio based on the last 12 months of earnings.

The prices of long-dated Treasury bonds usually move opposite to the SP500.  In the month after the election, stocks rose and bond prices went lower.  Since mid-December an ETF composite of long-dated Treasury bonds (TLT) has risen slightly.  A number of investors are wary of the expectations that underlie current stock valuations.

The casual investor might be tempted to chase those expectations.  The more prudent course is to stick with an allocation of various investments that manages the risk appropriate for one’s circumstances and goals.


Cliff Diving

November 18th, 2012

This past week, President Obama gave a post-election news conference, answering a number of questions about the fiscal cliff due to take effect on January 1st if the lame duck Congress and the President can not come to an agreeement on some budget bandaging.  The stock market has had the jitters since the first week of October, falling 9% since then; about half of that decline came after the election.  At almost the same hour that it became apparent that the balance of power in Washington would remain the same came the unwelcome forecast of no growth for the Eurozone in 2013.  When in doubt, get out.

For the past two years, there have been few “Kumbaya” moments in the halls of Congress or the White House.  The market has had a good run this year; capital gains taxes could increase next year; many decided to take their profits and run.  A I wrote a month ago, the drop in new orders for durable goods was troublesome.  Three weeks ago, the newest durable goods report showed further declines yet consumer confidence was up, creating a tug of war and I waved the yellow flag, saying that the “prudent investor might exercise some caution.”

For the long term investor who makes annual investments in their IRA, this drop in the stock market is an opportunity to make some of that contribution for this year.  If the wrangling over revenue and spending cuts continues over the next few weeks, the market could drop another 10 – 15%. When budget negotiations collapsed in July – August 2011, the market declined almost to bear market territory – about 19%.  All too often, some of us wait till the last minute in April to make our annual IRA contribution. 

The “cliff” terminology was spoken by Fed Chairman Ben Bernanke at a hearing in February.  He probably wished he had chosen less colorful language but he was probably trying to wake up some of the senators at the hearing.  How bad is this cliff?

The total measured economic output of the U.S., its GDP, is estimated by the BEA (Bureau of Economic Analysis) at around $16 trillion – $15.85 trillion, to be exact, based on this year’s estimated growth of about 2.2% and next year’s average 2.75% estimate of growth.  What’s a trillion dollars?  About $9000 for every household in the country.

The non-partisan Congressional Budget Office (CBO) estimated some of the economic impacts if we did go over the cliff; in other words, if the spending cuts and revenue increases occurred next year.  Below is a chart of the percentages of GDP that each component of spending cuts and revenue were to occur.

The total of these is 3.2% of the economy.  Well, that’s not Armageddon, you might think and you would be right. As I mentioned earlier, forecast growth is only about 2.75% for next year so that means that GDP would contract slightly next year.  On the other hand, the cliff sure helps the deficit for next year, cutting it by almost half.  The deficit is projected at about $1.1 trillion before spending cuts and revenue increases.  In more manageable numbers, the country is going to go further into debt next year to the tune of almost $10,000 for every household.

Politicians in front of a microphone are prone to hyperbole.  So are news anchors.  Politicians try to sell their version of the story; news anchors try to keep our attention.  Small numbers like 3.2% of GDP might not get our attention so we could hear more dramatic numbers.  News anchors may say “Spending cuts of $100 billion” because $100 billion sounds important.  But without a total or a percentage, we have no context to evaluate the amount of money.  Is $100 billion a little or a lot?  $100 billion in spending cuts is .6% of the entire economy, or 2.6% of the budget for this coming year.  We may hear “Revenue increases of $400 billion,” which sounds gigantic.  It is 2.5% of the economy, or an additional 13.8% of the projected federal revenue.  Remember, even with the revenue increases, should they take effect, the country’s budget will still be “in the red” an estimated $600 billion dollars, or $5400 per household.

This country needs more revenue and it needs to cut expenses.  Each side of the aisle will fight to protect the “job creators” (interpretation: people with money) or the “working poor” (interpretation: people who are barely making it week to week) or the “middle class” (interpretation: the rest of us).  Tax the other guy, not me.  Cut the other guy’s deductions, not mine.  Cut subsidies, but not mine.  Cut expenses but not in my industry or area of the country. This is the same kind of behavior that 5 – 8 year old kids exhibited in an experiment featured on CBS’ 60 Minutes tonight.  Maybe, just maybe, we need to grow up.

Budget Buster

In his weekly WSJ Capital column of 4/9/09, David Wessel reviews the CBO projections for President Obama’s proposed budget.

“The issue isn’t today’s deficit. Deficits are supposed to widen at times like this. The issue is the size of the deficit .. when the recession is past.” A CBO graph of U.S. debt, the deficit, is not pretty going forward. In 2007, the deficit was a little over a third of GDP. It is projected to go to 54% of GDP.

Rising health care cost have become the primary concern of budget projections, as the Director of the CBO notes. “Over the past 30 years, total national spending on health care has more than doubled as a share of GDP.” That doubling is not double the cost, but double the percentage of GDP. GDP has grown six-fold, meaning that health care costs have risen by a factor of 12.

This CBO graph from January 2009 of Debt Held by the Public as a Percentage of GDP from 1968 to 2010 is interesting. (Scroll down a few graphs to get to this one) Now look at a comparison of the January projection and the revised projection based on Obama’s budget. By 2012, projected Federal revenues will be about 18% of GDP and continue at that level for 7 years, till 2019. Spending will be 23% of GDP and climb to almost 25% of GDP.

Wessel notes that “Republicans, such as Wisconsin Rep. Paul Ryan, counter with proposals that combine tax cuts with spending cuts so severe that even a Republican Congress probably wouldn’t pass them – and still show significant deficits through 2019. So either taxes as a share of GDP rise or spending on those popular benefit programs (or everything else) is throttled back.” Wessel concludes his article with a sobering summary: “For 15 years, the Americans people have been told they could have it all. They deserve to be told that they can’t have it all in the future.”

For a historical perspective, take a look at CBO projections in 2003, forecasting an approx $16B GDP in 2009 and an unemployment rate of 5.2%. Recent, and more accurate, projections for 2009 are $14.2B in GDP with an unemployment rate of 8.3%.

As we can see, projected deficits for the coming years look bad and those projections do not take into account unpredictable events like another attack on the U.S., an escalation of violence in Iraq, a continuing cascade of business failure leading to unemployment above 10%.

Every year the Social Security Administration sends each of us a statement of projected monthly benefits when we retire. Don’t count on getting all of that.

Household Debt

David Greenberg, author of Nixon’s Shadow in WSJ 3/21/09: “Reagan was struggling to pass his tax cuts when John Hinckley’s bullets landed him in the hospital. The outpouring of sympathy, aided by Reagan’s winning bedside humor, buoyed his popularity and helped him win a big victory. But that success didn’t foreshadow any continued mastery of Congress; his relations with the Democratic House, and later, the Senate, would deteriorate.”

For the first 6 years of the two term Reagan presidency, the Republicans controlled the Senate while the Democrats controlled the House. The last two years of his presidency, the Democrats controlled both houses.

In 1980, total Federal receipts, including Social Security taxes of almost $120B, were $517B. In 1988, total receipts were $909B, including SS taxes of almost $264B (U.S. Dept of Treasury).

In 1980 the Federal Debt was $907.7B; in 1988 it was $2602.3B. The deficit had almost tripled.

At the end of 1980, the CPI-U index was 86. It was 120 when Reagan left office.

In 1988, the top marginal tax rate was 28%. In 1980, it was 70%. Some argue that lowering tax rates dramatically raises tax revenues. The data above shows that tax revenues did increase, although the increase was not dramatic. Excluding Social Security tax receipts and adjusting for inflation, net tax revenues increased 16% in 8 years. Will lowering marginal income tax rates always produce increased tax revenues? Is there some optimal income tax rate? I’ll look at different theories on that subject in a future blog.

How much of this tax revenue increase came from capital gains taxes? The Dow Jones index stood at 930 when Reagan took office. It was 2239 when he left. I will take a look at that in a later blog but here is a 1997 congressional committee discussion of capital gains tax rates.

The data does show one very clear point. Increasing tax revenues can not offset runaway spending.