We know it’s been a particularly unfortunate year for fiscal management in the United States. The year 2023 has seen an especially contentious debt-ceiling standoff resolved in just the nick of time; a reduction in the nation’s credit rating for only the second time ever; and a budget stalemate so rancorous that it resulted in the forced removal of a House speaker from his job for the first time in U.S. history.
In spite of these developments, it seems the government remains devoted to wading ever further into the sea of red ink. During a fiscal year that saw the annual budget deficit hit $1.7 trillion – the third-biggest deficit ever – Treasury announced plans to borrow record quarterly sums through the near term. And those announcements spooked global investors in U.S. debt to such a degree that it sent Treasury yields to their highest levels in 16 years.
In concert with the continued emergence of these signs of imprudence, warnings about America’s fiscal unsustainability seem to be growing louder. And let’s be clear: Those doing the warning are by no means members of the fringe financial community.
One is Bill Dudley, former president of the Federal Reserve Bank of New York, who last month told the assembled at a conference in Sydney, Australia, “We’re absolutely on an unsustainable trajectory,” referring to the U.S. fiscal outlook.
Another notable expert who recently issued a public warning about the country’s fiscal future was none other than Federal Reserve Chairman Jerome Powell. Speaking before an audience at the Economic Club of New York in October, Powell declared, “The path we’re on is unsustainable,” adding, “We’ll have to get off that path sooner rather than later.”
These recent warnings come not only against the backdrop of what has been a particularly troubling year in terms of fiscal management, but also in the midst of brand new projections that imply fiscal uncertainty will only grow more uncertain, going forward.
For example: In a recent analyst note, Bank of America strategist Michael Hartnett suggested that U.S. gross national debt, which right now is at $33.8 trillion, will surge by another $20 trillion in just the next 10 years to reach $54 trillion by 2033.
Attributing that growth projection to anticipated “fiscal excess in the 2020s,” Hartnett says debt is on pace to rise by $5.2 billion every day for the next decade.
So, projections of fiscal “unsustainability” – both general and specific – continue unabated. And as they do, the question is beckoned:
What, exactly, is the tipping point?
That is, at what point does this much-referenced “unsustainability” morph into an actual debt crisis with potentially serious consequences for both the domestic and global economies?
As it turns out, the folks at the Penn Wharton Budget Model have an idea about that.
The Penn Wharton Budget Model is an applied research organization that focuses on the fiscal and economic impacts of U.S. public policy. And according to recent analysis by Penn Wharton, the U.S. has, at best, roughly 20 more years to make material changes to its current fiscal outlook – after which they estimate a significant default is all but assured.
We’re going to break that projection down further and give it a closer look this week. We’ll also look at concerns raised just a few days ago by Nathan Sheets, Citigroup’s eminent global chief economist, about where the “tipping point” to fiscal failure might be and how we might get there. And as we close out this week, we’ll detail what one prominent economist and public policy expert thinks an actual debt crisis might look like.
Could we really be 20 years from reaching the proverbial “point of no return” when it comes to a real debt crisis in the U.S.?
We’ve been hearing about how “unsustainable” the nation’s long-term fiscal trajectory is for decades. Yet for as long as we’ve been hearing that same refrain, few have managed to put a “fine point” on the proclamation and provide details in the way of a more specific timeframe.
The Penn Wharton Budget Model is trying to do so. In a recent piece of analysis, researchers there have concluded the nation has roughly two more decades to clean up its fiscal act in a meaningful way in order to avoid what could be a true fiscal disaster. If it fails in that effort, says Penn Wharton, then the ratio of publicly owned federal debt to gross domestic product (GDP) could be so large that a debt crisis of substantial proportions will be impossible to avoid.
Of the roughly $33.8 trillion in “public debt outstanding,” i.e., the gross national debt, about $6.9 trillion is money the government essentially owes itself. The rest – $26.8 or so trillion – is the federal debt owned by the public, and it is that variable, says Penn Wharton, that makes all the difference in determining national fiscal sustainability.
Right now, the ratio of debt held by the public to GDP is about 98%. That means it’s almost equal to the nation’s total economic output. That’s a lot. It can afford to go higher, but it just can’t go higher forever, according to analysts.
Penn Wharton says the maximum “magic number” is 200% of GDP. That is, if the public’s share of the debt exceeds 200% of GDP, the U.S. will default. And the consequences could be significant and global in scale.
To clarify, however, that is the maximum, in the view of Penn Wharton. They say the tipping point might be less than that.
“This 200 percent value is computed as an outer bound using various favorable assumptions: a more plausible value is closer to 175 percent, and, even then, it assumes that financial markets believe that the government will eventually implement an efficient closure rule,” Penn Wharton analysts clarify.
“Once financial markets believe otherwise,” they add, “financial markets can unravel at smaller debt-GDP ratios.”
Eminent Economist: “Prudent Path for Fiscal Policy…Is to Not Push Debt Ratios Further Upward”
Earlier this week, Nathan Sheets, Citigroup’s global chief economist who also served in high-ranking positions at both the Federal Reserve and the U.S. Treasury, weighed in on at what point he thinks the ratio of debt held by the public to GDP might prove to be a genuine problem. And while Sheets is a little less specific than Penn Wharton about just where that tipping point might be, he does imply that the “danger zone” might be entered when that ratio rises to north of 150% – which is in the same neighborhood as Penn Wharton’s projection.
“There is no way to predict danger thresholds or the amount of debt that is simply ‘too much,’” Sheets writes in the Financial Times. “It is possible that US debt could rise to 150 percent of GDP or even higher with limited adverse effects. But it is unwise for policymakers to experiment or test where the thresholds might be.”
“The prudent path for fiscal policy is, at a minimum, to not push debt ratios further upward from today’s elevated levels,” he added.
Sheets doesn’t envision debt ratios not continuing to climb, however, saying, “There is little likelihood of meaningful remedial action.”
The reason is simple – and the same one we know all too well: political expediency. Noting that “tough reforms” are required to change the current fiscal trajectory, Sheets explains the respective impediments to those reforms for which each major party is responsible.
“Republicans are broadly unwilling to entertain discussions of tax rises,” he writes, “while Democrats are similarly unwilling to contemplate entitlement reforms.”
And, assuming no profound changes are made to U.S. fiscal policy, how long will the journey to the tipping point actually take?
“Under current policy, the United States has about 20 years for corrective action after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt,” Penn Wharton says.
According to Penn Wharton, it even could be in as little as 17 years from now, “depending on the assumed interest rates.”
And if the appropriate “corrective action” isn’t taken?
“Unlike technical defaults where payments are merely delayed,” notes Penn Wharton, “this default would be much larger and would reverberate across the U.S. and world economies.”
Let’s talk a little more about just what that reverberation might feel like.
The consequences of a major U.S. debt crisis are unknown…for the simple reason that we’ve never had one. The U.S. has not defaulted on its debt at any point in history.
But the speculation by appropriately qualified analysts of what would happen if that especially unpleasant eventuality were to come to pass seems to always seems to paint the same picture.
Some years ago, a comprehensive article in the National Tax Journal – coauthored by economist and public-policy expert Leonard E. Burman, Jeffrey Rohaly, Joseph Rosenberg and Katherine C. Lim – sought to determine, as best it could, what the fallout from a significant U.S. fiscal crisis would be. And its assessments seem to be about as reasoned as any I’ve ever come across.
As I noted at the top of this article, recent announcements by Treasury that it expects to borrow record quarterly sums through the near term sent yields soaring to their highest levels in more than a decade and a half. The Tax Journal piece suggests that rate reaction would be further intensified in the case of a dramatic loss of investor confidence in the viability of U.S. debt.
“Interest rates would increase dramatically when investors decide that U.S. bonds are no longer a safe asset,” Burman and the others say in the article. “One possibility is that Treasury rates rapidly rise as investors update their beliefs about the future solvency of the U.S. government or their beliefs about what other investors believe about the future solvency of the U.S. government, causing Treasury bond prices to drop and yields to soar.”
The Tax Journal article notes that while the government might be able to continue borrowing, it would have no choice but to pay an enormous risk premium for the privilege, adding, “The suddenness and magnitude of the increased borrowing costs for the government would have major macroeconomic repercussions.”
And that wouldn’t necessarily be the worst of it.
“The more dramatic scenario involves an immediate freezing of the U.S. Treasury market altogether and an inability of the U.S. government to roll over debt that is coming due in order to make interest payments on other existing government debt or to fund government activities,” say Burman and the other authors. “In this case, no one is willing to lend to the U.S. government at any interest rate.”
Under those circumstances, say the authors, nothing short of massive tax hikes and equally massive spending cuts would convince creditor nations and domestic lenders to participate in the U.S. debt marketplace.
And the problem with that, say Burman and friends?
“A dramatic fiscal contraction could hurt both United States and world growth to such an extent that even the restructured debt could not be paid back and the ground instead would be laid for future defaults,” they write.
We are not there yet, of course. But that which was at one time inconceivable when it comes to worst-case U.S. fiscal outcomes is not so inconceivable anymore. And the fact that such outcomes not only now are conceivable but subject to consideration in mainstream financial communities speaks volumes, in my opinion, about the possibility that they could become reality unless our nation’s leaders urgently apply vastly improved fiscal stewardship.
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