Sunday, March 7, 2021

How will the $1.9 Trillion stimulus plan be paid for?

by Rod Williams, 3/7/2021 - The Senate passed the $1.9 Trillion stimulus bill yesterday with only minor changes from the House version. By anyone's calculations, $1.9 trillion is a lot of money. I contend the bill passed is not really a stimulus bills and not near that much is needed and that the bill is laden with pork that has nothing to do with the pandemic and may in fact, delay the recovery.  I explain my opposition to the bill in a  post you can read at this link.

This post is not to reargue points made in the previous post.  I am not arguing the merits of what is in the bill this time but attempting to explain how a $1.9 trillion price tag could be a disaster for our economy and drastically change the nature of America. This is pretty elementary economics, so if it this is too elementary for you and will bore you, you can move along.

Tax revenues are the primary source of funding for governments.  However, just like a household wants things it cannot afford with current income, government does to.  To have those things, like households, governments borrows money.  They borrow to build roads, fight wars, provide welfare, cover payroll, and lots of other things.  Any government spending not covered by tax revenues is financed by borrowing. Borrowed money, of course, is called debt. Debt is not free. When government borrows money it has to repay it. (This is mostly true, The exception is monetizing the debt.)  Issuing debt today means we will have to pay for it in the future.  When those who are critical of government debt say things, like "we are stealing from our children and grandchildren," that is what they mean.  

Deficits and Debt: Before going further it is time to clarify some terms.  The government runs a deficit anytime it spends more money than it takes in. Usually when the deficit is mentioned it is for a single fiscal year, but doesn't have to be; it could be any period.   Debt is the amount of total money the government owes.  The total of all of the budget deficits add up to the debt.

The total debt of the US government now is about $27.9 trillion dollars.  If one takes the total debt of the United States and divides by the number of people that comes to $84,683. To pay off the federal debt, would require each man, women and child paying $84,683

The debts is paid back though collected taxes for the most part.  Paying off the old debt or just paying the interest on the debt is called "debt service."  Put simply, that is money earned or received today to pay on debt previously created.  Think of a household with credit card debt.  Each month, part of that household income goes to pay credit card bills.  So, paying today for money you spend in the past means you do not get to spend that money now.  Often households and governments keep borrowing more to pay for past borrowing. Currently interest on the federal debt paid out of current revenues takes about 10% of current revenue.

Some will say, "This is nothing new. When Trump was doing it, Republicans were fine with it."  To a certain extend that is justified criticism.  I was critical of spending under Trump but most Republicans were not.  However, Trump wanted his last stimulus bill to contain a $2000 per person payment and Republicans cut it back to $600.  Republicans did not stand up to Trump often enough, but they were for the most part more fiscally responsible than Trump. Trump was not a fiscal conservative. 

During Trump's time in office, the National debt shot up $7.8 Trillion.
The Trump deficit was the third largest relative to size of the economy in our nations history. The Trump Tax cut was a contributing factor.  The tax cut was never going to pay for itself.  Some ideologues object to use of the terminology that "a tax cut pays for itself,"  but it is useful.  A tax cut "pays for itself" when the new lower tax rate, by putting money in the hands of consumers, spurs economic growth resulting in the lower tax rate bringing in as much revenue as the old higher rate.  The Trump tax cut did spur growth but not enough.  Economist who studied the issue said it wouldn't.  The tax cut combined with spending cuts could have been at least revenue neutral but Trump had no appetite to push for cutting spending. Trump ballooned the deficit. Part of this was spending in response to the Covid-19 pandemic but part was simply misstatement and no appetite for cutting spending.

Allowing that there is truth to the criticism that Republicans only recently rediscovered fiscal responsibility, that does not justify unconcern with what adding $1.9 trillion will do to the deficit and debt. If you are a houshold trying to balance a tight budget and the wife goes out and spends an enormous amount of money on hair care and beauty products, it is not wise to go out and spend money on a new fishing rod, just to get even.  

 Look at these numbers: 
  • Federal Budget Deficit for January 2020: $33 billion
  • Federal Budget Deficit for January 2021: $163 billion 
  • Cumulative Budget Deficit through January FY20: $389 billion
  • Cumulative FY21 Deficit through January 2021: $736 billion 
We are in much worse shape now than in the past.  Since we already have a year-to-day, as the end of January, deficit of $736 billion, spending $1.9 trillion will be all deficit and debt.

So how big is the debt? What do those numbers mean? The Congressional Budget Office recently said that sometime this year, the total federal debt will exceed the size of the entire U.S. economy. If nothing changes, before adding another $1.9 trillion, we are headed for for the second worst deficit since the wartime spending of 1945. If you take the total value of every single item produced in the county and ever service provided, the total value would not pay off the national debt. This is kind of a measure of a country's fiscal responsibility.  When the World Bank looks at helping out some poor country, this is a figure they consider in determining if the country is fiscally responsible. 

But we have had huge debt before, have we not? Because we survived the only other instance of when the total debt exceeded the GDP, some think there is nothing to worry about.  Coming off of WWII was not comparable to coming out of this pandemic. In WWII, we had stopped domestic production of cars and lots of other things and we had rationing of even lots of foodstuff.  There was enormous pent-up demand.  Also, we were the only major wealthy country that had not been destroyed by the war.  Another factor is that we did not have Medicare and Social Security that gobbles up a large share of available revenue.  The situation at the end of World War II does not provide insight into the current situation. 

Who owns our debt? So what is the threat of so much debt? First of all, look at who owns the debt. A lot of people think it is China and China holds enough of our debt to be a concern, but only a little over $1 trillion. Japan holds the most at $1.26 trillion, the United Kingdom, Ireland and Switzerland add up to about $7 trillion of America’s debt. 

Part of the debt is "intragovernmental debt" where the government borrows from other agencies. This comes to about $6 trillion.  Most of that is money borrowed from the Social Security Trust Fund. Some people sensationalize this as saying the government raided social security.  The debt of the United States is a concern, but the concern is the debt, not that the Social Security Trust Fund has its savings in the form of instruments the equivalent of U. S. bonds. 

Social Security is not a retirement system like a pension but a transfer payment system like welfare.  Current retirees get their money from current workers who are paying into the system. Social Security is projected to grow at a rate greater than the GDP for the foreseeable future. The Social Security Trust Fund will run out of money in 2031 and then, if only revenue funds the system instead of revenue plus money in the trust fund, social security payments will have to be cut by about a third.  People will not stand for that and politicians will not allow massive cuts of that magnitude to Social Security. That is a problem and will put more pressure on the Federal government to run even higher deficits but that is an issue of the structure of Social Security and is not relevant to the current discussion beyond noting who owns the debt and the pressure for more debt. The balance of our national debt is held by individuals, pension funds and the Federal Reserve. 

So what is the problem?  One, has already been mentioned.  As we borrow more, it takes more of current revenue to pay interest on the debt.  If there is any bright side to this much debt, it means there is less debt availability to fund things like Medicare for All or The Green New Deal.  Also, however it means there is less available funds to modernize our crumbling infrastructure and engage in other desirable spending. 

 It also means there is less to modernize our military to confront a growing Chinese threat and keep the peace. In hearings before Congress members of the Joint Chiefs of Staff and foreign policy experts routinely say the national debt is one of the major US security concerns. China is on an aggressive policy of expanding their influence in Asia as well as Africa and other places in the world.  We are slow to counter this threat.  India is being neutralized and Taiwan is under greater threat. Allies such as South Korea and the Philippines are nervous. South East Asia is kowtowing.  At a time when we need to be showing greater strength and showing  greater resolve to keep the peace, we are failing.  Some, isolationist and Pollyannaish pacifist may be pleased if we withdraw from world affairs and give up our leadership role.  I see it as a disaster if we do so.

Another problem with this level of debt is that when savers, either pension funds or individual investors or foreign governments, buy American government debt that is money that was not invested in new technologies, and research and development, and job growth.  Government debt pulls money out of investments that would grow the economy.  For a long time America has been the richest county in the world and a leader in economic growth.  We are slowing.  If we someday envy the economic vitality of countries that are out performing the US, our debt will not be the only thing to blame but lack of investment due to government debt squeezing out investment in the private sector will be one of the major causes.

Another problem is that debt held by our adversaries weakens us in relationship to them. If China were to dump the American debt they hold onto the market, US bond prices would drop and this would force the government to increase yields. That would make borrowing more expensive for the government. That would also make loans for US corporations and private borrowers more expensive, slowing US growth. That means lost jobs of course, but also less revenue for the government.  If is not wise to let your adversary have that kind of control over you. 

The last reason for concern is the big one. There may be a catastrophic event that causes a debt spiral and an economic collapse. Now, savers world wide view the US as a safe place to put their money.  We may be the wellest man in the sick ward, but by comparison we look pretty strong.  Now, the world believes America is the safest place to keep its money. Assume something happens like the financial crisis of 2006, or assume a combination of things happen like the financial crisis of 2006, a pandemic out of control, and a 9/11 type terrorist attack.  We have already eaten up our debt capacity. Debt greater than GDP is already a sign of unhealthy borrowing.  That is what sick countries do that the World Bank puts on an austerity diet. With a cataclysmic financial event, we would have to greatly increase interest rates to attract new investors and that would increase debt service and we would have to borrow more just to meet payroll and keep the lights on.  This is not far-fetched. It is hard to predict but we have no margin. We have already cashed in the insurance policy. The next time we need debt to meet a crisis the cost will be much higher. 

This essay purposely simplified things and I did not talk about what happens when we borrow from the Federal Reserve which is called "monetizing the debt," or sometimes euphemistically called "printing money."  That carries its own risk of higher interest rates and slower economic growth and the risk of run away inflation if it is a practice in which we overindulged .  It is not a solution to the problem of a large national debt. 

For some of the source material and to learn more, see these links:  linklink, link, link, link.

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