Do you know your net worth? If you add up all your assets (cash, property, etc) and subtract all your liabilities (debts), do you know what you are worth?
As a person, your net worth on paper doesn’t really account for your intangibles, like personality, education, or dashing good looks. Just your value if you sold everything you own.
Now how about the United States? What is the net worth of our “of the people, by the people, for the people” government? If we were to add up all the assets and liabilities, what would our country be worth (or owe, as the case may be)?
The question matters. Though we hear a lot of talk about deficits, earmarks, and budget cutting, there is a world of difference between what politicians usually deal with–discretionary spending–and what is the biggest debts on the US balance sheet–the entitlements.
Let’s look at the stuff we hear a lot about: cutting the discretionary spending in the federal budget. In reality, this is one of the smaller items on the federal balance sheet, but it’s the one that gets the most play in the news. For example, look at this visualization by William Gross:
Look at “Non-Defense Discretionary” on line three of this (extremely) simplified federal budget. In 2011, non-Defense Discretionary items will make up just a quarter of the budget. Over the last 40 years, it makes up on average only 23%. I doesn’t change that much. In other words, when we hear about politicians cutting discretionary items, they’re just chopping at the leaves, but leaving the trunk relatively unscathed.
That trunk is the other 75% of the budget. It’s stuff that Congress doesn’t mess with, can’t mess with, or, and here’s the kicker, is afraid to mess with. We’re talking entitlements, defense, and interest payments on the debt the United States owes to creditors. This means Medicaid, Medicare, Social Security, the Departments of Defense and Homeland Security, and, of course, interest payments on debt to, increasingly, people who live overseas and have loaned the US government money.
Of those, the scariest, the piece of the budget that is the largest, and that is going to grow the fastest in the coming decades, too, is the entitlement part. It’s Medicaid, Medicare, and Social Security. And it’s not even funded. The Congress has promised these benefits to people without coming up with a way to pay for them.
Remember, were talking liabilities, here, and unlike Defense spending, which has been fairly constant over the last forty years, entitlements will grow at a rate faster than tax revenues. Because they are unfunded, and because they will grow rapidly over the coming decades, the government will need to borrow to pay for them. As a result, as they grow, they’ll be paid for with more debt, which will increase the size of the interest payments.
Check it as Gross explains the danger:
The above four multi-trillion-dollar liability balls are staggering in their implications. Remember first of all that the nearly $65 trillion of entitlement liabilities shown above are not some estimate of future spending. They are the discounted net present value of current spending should it continue at the projected demographic rate (importantly – it is much higher than the annual CPI + 1% used as a discounter because demand for healthcare rises much faster than inflation.) And while some Honorable Congressional Le Pews would counter that Medicaid is appropriated annually and therefore requires no discounted reserve, those words would surely count as “sweet nothings,” believable only to those whom they romance every several years at the polls. The incredible reality is that the $9.1 trillion federal debt that constitutes the next-to-tiniest ball in our chart is nothing compared to unfunded Medicaid and Medicare. It is like comparing Pluto to Saturn and Jupiter. The former (the $9.1 trillion current Treasury debt) does not even merit planetary status in our solar system of discounted future liabilities. It’s really just a large asteroid.
Look at it another way and our dire situation becomes equally revealing. Suppose that the $65 trillion of entitlement liabilities were fully funded in a “lockbox,” much like Social Security is falsely imagined to be. Just suppose. And say the cost of that funding (Treasury debt) was the same CPI + 1% that was used to produce the above discounted present value in the first place. Actually, that’s not a bad guesstimate for the average yield of all Treasury debt. If so, then the interest expense on the $75 trillion total debt would equal $2.6 trillion, quite close to the current level of entitlement spending for Social Security, Medicare and Medicaid. What do we pay now in interest? About $250 billion. Our annual “lockbox” tab would rise by $2.35 trillion and our deficit would be close to 15% of GDP! The simple conclusion would be this: Unless you want to drastically reduce entitlement spending or heaven forbid raise taxes, then Pepé, you’ve got a stinker of a problem.
What would happen if we threw in agency debt and student debt, too, liabilities that the federal government insures? Add another $65 Trillion to the debt side of the balance sheet.
Indeed, because entitlement costs are going to continue to grow, and faster than inflation, sometime in 2040, mandatory budget items will exceed government revenues (or taxes collected).
Ouch. As Gross says, were out Greeking the Greeks with our debt, here.
In the real world, when things get this bad for a company, or for a person, they become insolvent. Since were talking about a country here, and not just any, but one of the most successful countries, bankruptcy is not exactly an option. It would destroy the world economy.
Instead, Gross anticipates four avenues the government can take to diminish it’s debt problems, none very attractive, and none very wise:
- Contractual abrogation. In other words, it will stop paying its debts and honoring its contracts. Extremely unlikely.
- Speeding up and increasing inflation. Dramatically. He thinks this is likely, but not sufficient.
- Push down the value of the dollar. Already happening.
- Decrease Treasury yields to historic lows, penalizing savers, and hope not one complains.
Or they could just reform entitlements. Entitlements are the heaviest weight on the federal balance sheet, and they are the part that will grow over the coming decades. Get entitlements under control, and suddenly the federal balance sheet is more manageable.
Who’s going to take it on? It’s political suicide for any serving politician to take on entitlements, and I doubt any of them currently serving has the courage, or the brains, to figure out how to do it.
Maybe it’s something that takes a whole generation. Maybe it’s time for the Baby Boomers to step forward. As Michael Kinsley recently wrote in The Atlantic Monthly, maybe it’s time for the descendants of the Greatest Generation to step forward and take one for their kids. Maybe it’s time to take one for the team:
So what do you give the country that has everything? You give it cash. The biggest peril Americans now face isn’t Islamo-fascism. It’s our own inability to live within our means. It would be nice to give our country the wisdom and self-discipline to stop running up the credit card. And we should try. But it’s unlikely that we can remake the national character (including our own) in 19 years. What we can do is offer a lecture and a fresh start. We should pass on to the next generation an America that’s free from debt. Instead of ignoring it, or arguing endlessly about whose fault it is and who should pay for it, Boomers as an age cohort should just grab the check and say, “This one’s on us.”
(h/t to PIMCO)
- When is $100 billion not enough? (lawafterthebar.wordpress.com)
- Gross calls U.S. budget a Greek tragedy (finance.fortune.cnn.com)
- GOP plans $1 trillion cut to Medicaid (politico.com)
- Why the federal budget is like a road trip…at 174 miles per hour. (lawafterthebar.wordpress.com)
- SOTU: It Made Me Laugh, It Made Me Cry But Mostly It Left Me Wondering If They Teach Basic Math At Harvard (hollyonthehill.wordpress.com)
- the sound of a bubble popping? (lawafterthebar.wordpress.com)
- The Human Cost of Ignoring Medicaid Reform (lawafterthebar.wordpress.com)