Another Danger Sign: US Debt Eclipses Economic Output

The US national debt has now broken the $15.033 trillion level, which is higher than the $15.032 trillion gross domestic product. This means that the country's debts are higher than it's annual output.

Monday, 21 Nov 2011 06:24 PM
By Forrest Jones
Money News

The United States has joined the rogues gallery of nations whose debt has exceeded its annual economic output, or gross domestic product (GDP).

The U.S. national debt has broken $15.033 trillion, higher than the $15.032 trillion gross domestic product, meaning as of now, the country's debts are higher than its annual output, according to usdebtclock.org, citing government data.

That's serious, says Gennaro Bernile, a professor of finance at the University of Miami.

"The message is very simple: the minute that the debt becomes as large as GDP, GDP has to start growing more than the interest that the U.S. pays in order to keep up with the debt."

That's just to break even and assuming the U.S. doesn't get dragged back into another recession.

"If the debt and the GDP are at the same level, and with the debt you have to pay interest at 1 percent, that means that next year the growth in GDP has to be at least 1 percent to keep just with the interest payments," Bernile adds.

Like in Europe, U.S. policymakers must decide what steps to take to reduce debt burdens, as tough austerity measures often lead to reduced government, and reduced government leads to reduced public-sector payrolls, and that means less tax revenues going back into the Treasury.

"The big debate is how do you reconcile shrinking the government with not killing the economy, because the government is a big chunk of the economy, and if you shrink the government you shrink the economy," Bernile says.

Other experts point out that should debt exceed GDP due to a cyclical dip in the economy, don't worry about the sky falling.

But when debt exceeds GDP due to structural reasons, such as not matching spending with revenue, then the situation will get dicey.

"If it's structural, that's a problem," says Steve Blitz, an economist at ITG Investment Research.

"If the economy is growing faster than the government is paying for that debt, then what will happen over time is that debt will just shrink relative to GDP as long as the budget deficit is going down. You get into trouble when you have an enlarged and growing structural budget deficit, and that comes from a misalignment of taxes and entitlements, and that is a problem."

The country did enter the recession running structural deficits thanks in part to the Bush tax cuts, increased military spending and changes to Medicaid prescription policies, Blitz says.

"You ramp up your spending, you cut your taxes and as a result you created what you would call a structural deficit."

But there is a way out, at least for the United States.

Spending will decline on its own as President Obama's stimulus programs wear away and people return to work, military campaigns in the Middle East wind down while a better economy results in higher tax revenue.

Furthermore, the interest paid on U.S. debts are very low, and as the economy expands, growth will exceed the rate of interest paid on the debt.

"As a result, that will also work to bring down the debt-to-GDP ratio," Blitz says.

"The problem you have in Italy and Greece is that they are paying interest on their debt that is way above the rate of growth of their economies."

The U.S. shouldn't get complacent, though.

"Are we in that situation today? No we are not. Can we get there? Yes."

Medical costs are rising, and so are pensions even in private corporations, but political leaders spend more time politicizing the issue.

"It would really be nice if people in Washington began to act like adults," Blitz says

"This is an economy-wide problem, it's not a Republican problem, it's not a Democrat problem, it's not a liberal problem or a conservative problem. It is an issue that the U.S. economy faces."

Others point out the country is spending too much but add it's not too late for the U.S. to work its way out of its hole.

"I do not think this is a no-win situation. I do think it is reversible. The biggest problem is we need to act now. We can't sit around and wait for the economy to get better. We have to be fiscally responsible," says economist and author Mark Skousen.

"What it takes is leadership, and we don't have leadership."

That means leadership is lacking at the White House, Skousen adds.

It also means the country needs a simplified tax code.

Take the Bush tax cuts — they weren't permanent but should have been.

Plus the tax code is confusing and hard to manage.

"I always point to Hong Kong as the best example. Hong Kong has had the same tax code for 50 years. It's basically a progressive tax code with a maximum of 16 percent to 18 percent on individuals and businesses. We need that kind of tax planning," Skousen says.

Some argue that the government needs to raise taxes to help narrow deficits, which almost always means tax hikes.

That doesn't work either, Skousen says, adding that raising taxes will only encourage more spending.

"If you raise taxes it means they have more leeway to spend more money," Skousen says, referring to policymakers, who almost always ask how much revenue is coming in when planning budgets.

"You let them off the hook."

A Super Committee made up of 12 lawmakers, six Democrats and six Republicans, has been working on a plan to cut at least $1.2 trillion from the country's deficits, but has failed.

"After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee's deadline," the panel's co-chairs, Republican Representative Jeb Hensarling and Democratic Senator Patty Murray, said in a statement on Nov. 21, CNBC reports.

Market watchers say they weren't surprised.

"These days it's pretty hard to have confidence in the political side of things," says Rick Bensignor, chief market strategist at Merlin Securities in New York, CNBC adds.

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