When Does US Federal Debt Reach an Unsustainable Level? – MishTalk

An interesting article by Penn Wharton, University of Pennsylvania, says the limit of debt as a percentage of GDP is about 200 percent, When does that happen?

Penn Wharton Budget Model (PWBM)

Summary: PWBM estimates that—even under myopic expectations—financial markets cannot sustain more than the next 20 years of accumulated deficits projected under current U.S. fiscal policy. Forward-looking financial markets are, therefore, effectively betting that future fiscal policy will provide substantial corrective measures ahead of time. If financial markets started to believe otherwise, debt dynamics would “unravel” and become unsustainable much sooner.

Please consider When Does Federal Debt Reach Unsustainable Levels?

Key Points

• The U.S. “public debt outstanding” of $33.2 trillion often cited by media is largely misleading, as it includes $6.8 trillion that the federal government “owes itself” due to trust fund and other accounting. The economics profession has long focused on “debt held by the public”, currently equal to about 98 percent of GDP at $26.3 trillion, for assessing its effects on the economy.
• We estimate that the U.S. debt held by the public cannot exceed about 200 percent of GDP even under today’s generally favorable market conditions. Larger ratios in countries like Japan, for example, are not relevant for the United States, because Japan has a much larger household saving rate, which more-than absorbs the larger government debt.
• 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 whether explicitly or implicitly (i.e., debt monetization producing significant inflation). Unlike technical defaults where payments are merely delayed, this default would be much larger and would reverberate across the U.S. and world economies.
• This time frame is the “best case” scenario for the United States, under markets conditions where participants believe that corrective fiscal actions will happen ahead of time. If, instead, they started to believe otherwise, debt dynamics would make the time window for corrective action even shorter.

Debt Clock

The Debt Clock and other sites exaggerate the problem.

If you have not seen the Debt Clos before, I suggest you click on the link. It is updated constantly and shows how fast things are getting out of hand.

Debt to the Penny

The US Treasury site Debt to the Penny separates out intragovernmental holdings without the constant update every second that makes the Debt Clock fascinating to watch.

The good news is that the debt clock exaggerates the problem. That is the extent of of the good news because the setup is still dire at current rates of debt growth. With that let’s return to the PWBM.

Importantly, in theory, the SSA interest rate projections are not intended to include the impact from historically unprecedented, mounting future government debt itself. Candidly, however, at this point, some arguments about debt and future rates become circular in modeling discussions. However, both authors are experts in SSA estimation methods—with one of the authors currently serving on the Social Security Advisory Board and the other author serving on its most recent technical panel. The larger SSA rate is mostly guided by historical averages rather than forward-looking estimates that incorporate future debt. Indeed, SSA generally does not attempt to incorporate federal debt into its own forecasts even though this debt can erode the size of the payroll tax base that supports benefits. We will return to this topic in another brief.

Table 1 then shows the impact on the debt-GDP ratio if financial markets start to demand a larger return before unraveling, equal to an additional 50 basis points (b.p.), 100 b.p, 150 b.p. and 200 b.p. Even the highest return at 200 b.p. is not far-fetched. However, additional rates closer to 50 to 100 b.p. are more reasonable in the short run, as some borrowing rates are already locked in at a weighted average duration of about 6 years.

Penn Wharton Projected Debt

The PWBM baseline suggests things will start to unravel around the year 2050.

But if interest rates are higher than projected by 100 basis points (one percentage point, e.g. 6 percent instead of 5 percent), things get out of control starting 2045.

Gold Has a Message

In case you missed it, please note that gold hit a new record high last week.

Debt to GDP Alarm Bells Ring, Neither Party Will Solve This

In case you missed it, please see Debt to GDP Alarm Bells Ring, Neither Party Will Solve This

“Neither party will fix the deficits. Neither party will do anything about mounting debt. No one will do anything about anything because the political system is totally broken.” Mish

That’s also the message of the Treasury market and gold. Bitcoin advocates would say Bitcoin as well.