US Debt On The Rise

From the Financial Times

Summit to tackle ballooning US deficit
By Edward Luce in Washington

Published: February 19 2009 19:56 | Last updated: February 19 2009 19:56

The Congressional Budget Office shocked global markets a month ago, when it estimated that America’s budget deficit would hit almost $1,200bn this year – a number that would shatter all postwar records. Four weeks later, the CBO’s projections look positively rosy.

Capitol Hill has since passed a $787bn (€620bn, £550bn) two-year fiscal stimulus. Barack Obama, US president, has announced $75bn in new spending to provide relief to struggling mortgage holders and an additional $200bn in contingent liabilities for the housing market via Fannie Mae and Freddie Mac, the state-owned mortgage providers.

Finally, Chrysler and GM have asked for another $21.6bn in state aid – barely a drop in the sea of red ink now enveloping Washington. This is without anticipating Treasury’s request for hundreds of billions to recapitalise the financial sector.

Mr Obama will host a bipartisan summit on fiscal discipline next Monday that will aim to address America’s long-term struggle to control entitlement costs in healthcare and social security. For most economists, it cannot come a moment too soon. “We are now looking at fiscal deficits of over a trillion [a million million] dollars every year for the next decade,” says William Gale of the Brookings Institution. “And that is without adding all the trillions of dollars in contingent liabilities of the Federal Reserve and the Treasury, which show up nowhere in the budget or national debt numbers.”

Under the CBO’s projections, America’s budget deficit will start to decline in 2010 and gradually reduce to 1.1 per cent of gross domestic product by 2019 – down from almost 9 per cent in 2009. But the CBO’s assumptions, which it is required by law to follow, are widely dismissed as fantasy.

For example, the CBO assumes that all of George W. Bush’s tax cuts will expire in 2010, even though Mr Obama has promised to retain them for all but the wealthiest Americans. It also assumes that the notorious Alternative Minimum Tax, which is postponed annually by Congress, will take effect. And it assumes no increases in discretionary spending.

Most economists, citing Milton Friedman’s dictum that there is “nothing so permanent as a temporary government programme”, assume that many items in the fiscal stimulus will be retained after two years have elapsed. Mr Obama has also said he will deliver on his promise for an expansion of healthcare coverage that could add up to $1,600bn in spending over the next decade, according to the Tax Policy Center think-tank.

Nor do the markets appear to believe the CBO’s forecasts. With an eye perhaps on the dramatic expansion of the Fed’s balance sheet, which has taken on more than $1,000bn dollars in new guarantees and loans in the past year, the bond markets are starting to price in an unthinkable possibility of US government default.

The implied risk of US government default in the market for credit default swaps has risen from 1 per cent to 6 per cent last September. Alan Greenspan, former chairman of the Federal Reserve, on Tuesday picked up on the recent steepening of the US Treasury yield curve to warn that it might lead to inflation.

“There is obviously a limit to the expansion of federal debt,” he said in a speech in New York. “The recent rise of long-term interest rates may be signalling market concerns about inflationary pressures.” On the outlook for spending cuts, Mr Greenspan added: “It would be foolish to disregard how American politics will shape the fiscal and monetary resolution of our current crisis.”

Maya MacGuineas, who heads the committee for a responsible federal budget, says Monday’s White House summit needs to set a credible agenda to begin a bipartisan effort to tackle America’s debt. Between October last year and October 2010, it is expected to have risen 43 per cent – or $2,500bn. That is without including any of the new commitments from the Fed and Treasury. Nor does it include the $1,500bn in debt held by Fannie and Freddie.

“We can safely say that our current system of public accounting is way out of date and that it seriously understates both the budgetary and debt implications of all these liabilities,’ says Ms MacGuineas. “It is 40 years old. We live in very different times now.”