Is the United States Bankrupt?

FEDERAL RESERVE BANK OF ST. LOUIS REVIEW ^ | July 1, 2006 | Laurence J. Kotlikoff

[Paul Ross]

Synopsis

Is the United States bankrupt? Many would scoff at this notion. Others would argue that financial implosion is just around the corner. This paper explores these views from both partial and general equilibrium perspectives.

It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future.

The paper offers three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized Social Security, and a globally budgeted universal healthcare system.

_Preface

Is the U.S. bankrupt? Or to paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bear, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors?

Many would scoff at this notion. They’d point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries.

Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mispricing securities; and that financial implosion is just around the corner.

This paper explores these views from both partial and general equilibrium perspectives. The second section begins with a simple two-period life-cycle model to explicate the economic mean-ing of national bankruptcy and to clarify why government debt per se bears no connection to a country’s fiscal condition. The third section turns to economic measures of national insolvency, namely, measures of the fiscal gap and genera-tional imbalance. This partial-equilibrium analy-sis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.

The world, of course, is full of uncertainty. The fourth section considers how uncertainty changes one’s perspective on national insolvency and methods of measuring a country’s long-term fiscal condition. The fifth section asks whether immigration or productivity improvements arising either from technological progress or capital deepening can ameliorate the U.S. fiscal condition.

--SNIP--[skipping ahead to the meat of the paper]

THE U.S. FISCAL CONDITION

As suggested above, the proper way to consider a country’s solvency is to examine the life-time fiscal burdens facing current and future generations. If these burdens exceed the resources of those generations, get close to doing so, or simply get so high as to preclude their full collection, the country’s policy will be unsustainable and can constitute or lead to national bankruptcy. Does the United States fit this bill? No one knows for sure, but there are strong reasons to believe the United States may be going broke.

Consider, for starters, Gokhale and Smetters’s (2005) analysis of the country’s fiscal gap, which measures the present value difference between all future government expenditures, including servicing official debt, and all future receipts. In calculating the fiscal gap, Gokhale and Smetters use the federal government’s arbitrarily labeled receipts and payments. Nevertheless, their calcu-lation of the fiscal gap is label-free because alter-native labeling of our nation’s fiscal affairs would yield the same fiscal gap. Indeed, determining the fiscal gap is part of generational accounting; the fiscal gap measures the extra burden that would need to be imposed on current or future generations, relative to current policy, to satisfy the government’s intertemporal budget constraint.

The Gokhale and Smetters measure of the fiscal gap is a stunning $65.9 trillion! This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one’s head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole. The answers are terrifying. One solution is an immediate and permanent doubling of personal and corporate income taxes. Another is an immediate and permanent two-thirds cut in Social Security and Medicare benefits. A third alternative, were it feasible, would be to immediately and permanently cut all federal discretionary spending by 143 percent.

The Gokhale and Smetters study is an update of an earlier, highly detailed, and extensive U.S. Department of the Treasury fiscal gap analysis commissioned in 2002 by then Treasury Secretary Paul O’Neill.

Smetters, who served as Deputy Assistant Secretary of Economic Policy at the Treasury between 2001 and 2002, recruited Gokhale, then Senior Economic Adviser to the Federal Reserve Bank of Cleveland, to work with him and other Treasury staff on the study. The study took close to a year to organize and complete. Gokhale and Smetters’s $65.9 trillion fiscal-gap calculation relies on the same methodology employed in the original Treasury analysis. Hence, one can legitimately view this figure as our own government’s best estimate of its present-value budgetary shortfall. The $65.9 trillion gap is all the more alarming because its calculation omits the value of contingent government liabilities and relies on quite optimistic assumptions about increases over time in longevity and federal healthcare expenditures.

_____________________________________________________

Laurence J. Kotlikoff is a professor of economics at Boston University and a research associate at the National Bureau of Economic Research.

© 2006, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.

[ancient_geezer]

Not tah worry, uz can jess "flipit" like they duz in realstate. (least that's what they tol me on the nite time telly)

[Eagles Talon IV]

I have been hearing this for over 40 years and I will hear it as long as I live. While what you say may be true today, there is no way to tell what will happen in the future, near or far. A large part of our liability is SS and Medicare/caid. Suppose both of these programs were put into the private sector and people funded their own, as has been proposed for SS. Suppose all education was done by private contractors who have already proved they can attain better results for less money? The Gov't will still pay but the cost per pupil will be far less and the unions will be out of it (if the private educators are smart)

My point is the nation will not go bankrupt simply because it cannot be allowed to go bankrupt. There is a saying that if you owe the bank 1 million dollars you are in trouble. But if you owe the bank 1 billion dollars the bank is in trouble.

AS things currently stand, if America goes down the financial tubes the rest of the world follows. Will this change in the future? Maybe, probably, but by the time that happens we will have had the chance to do something along the lines of what i have suggested. Will we do it? It depends on how much the morons in the Congress actually care about the country vs how much the care about getting re elected.

[pigdog]

So by that reasoning I guess China's in DEEP DOO-DOO (along with a lot of our other creditors)???

[RipSawyer]

At today's prices - 70 trillion dollars.

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

What is it minus estimated extractin costs?

[RipSawyer]

Extractin costs should be roughly equal to extraction costs 8 0 )

[RipSawyer]

.....hey, isn't a 'note' a debt instrument anyway?......

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Sometimes a note is a message, the message on the current Federal Reserve note is,"you're screwed, Buddy".

[Toddsterpatriot]

Sometimes a note is a message, the message on the current Federal Reserve note is,"you're screwed, Buddy".

Buy gold! I heard it was more stable than the dollar. That's not the same as never going down in value, is it?

[Dazedcat]

"stripped bear"


Actually that would be stripped bare..........but I get the drift.

I'm really not sure how much longer the US can stay strong with so much federal debt and such a huge trade imbalance still. The global capitalists here will no doubt tell me all is well, not to worry.

Maybe so, maybe not. As long as the foreign investment keeps coming into the country, and as long as the dollar remains the currency of choice on the petro market......then I guess things will go on as normal.

I'll keep investing in gold though. Thanks for the article.

[Conservative Goddess]

If I was preparing an audited financial statement for this government.....there would definately be a "going concern" note included in the report. The 'trust funds' are NOT actuarially sound, (in fact, they're non-existant) and absent substantial benefit cuts, or substantial tax increases, there is no way to make them actuarially sound. The ability of our government to continue on this path is based on a whimsical belief of the masses, trust, blind-faith, not sound economics.

The only thing separating this government from bankruptcy is the ability to print more money and to increase the debt ceiling. The ability to make future payments on entitlements is only guaranteed by future ability to tax the masses. There is nothing in the trust fund to put into the private sector to 'fund' future liabilities. How are you going to privatize the systems when the net present value of the unfunded liability (the amount that we would have to invest TODAY to make the SS and Medicare/caid systems actuarially sound) exceeds the net worth of the country? SMOKE AND MIRRORS are propping up this government.

The money previously withheld from employees and employers has been spent. It's gone. The current surplus is funding current, non-social security and medicare spending. Nothing is going into a 'lockbox.' I note with no small measure of disgust that if a private annuity salesman had done what the feds have done, he/she would be in jail for theft, fraud.

Privatization is a pipe dream because NO ONE has the cahones to stand up and tell the American people the truth: There's no money. We spent it. Sorry. You're on your own for retirement security and healthcare. That's the unvarnished truth.

[american spirit]

Gee, I wonder who made out better in when the market crashed in '29.....folks standing in line at the banks trying to salvage something of their savings or those that held onto their gold......might be good thing to know since history tends to repeat itself.

[Toddsterpatriot]

Gee, I wonder who made out better, people who bought gold at $800 an ounce in 1980 or those who put the money in the bank or in the stock market?

or those that held onto their gold....

How long did those people get to hold onto their gold? LOL!

[american spirit]

Sometimes you win, sometimes you lose.......and where you placing your bets these days given the deficits, unfunded liabilities to the tune of over 50 trillion+ and fed borrowing approx. 2 billion a day to keep this global economy ruse going?

[RobFromGa]

Why Debt Doomsday is a Myth

Our Teeny-Tiny National Debt

[Toddsterpatriot]

and where you placing your bets these days

Good dividend paying stocks mostly.

given the deficits, unfunded liabilities to the tune of over 50 trillion+

Yes, deficits and unfunded liabilities are bad. They'll probably have to raise taxes and drop payments to reduce those.

and fed borrowing approx. 2 billion a day to keep this global economy ruse going?

Please run me thru the steps that got you to $2 billion a day of Fed borrowing. Thanks.

[cope85]

This article has been deleted.
thanks to fr

[Paul Ross]

The first article by this Skeptical Optimist fails to note that countries do fail from excessive debt...each and every single one of them had available and used the same remedial devices he iterates as "solving the problem" notwithstanding an inevitable failure.

H'mmm. Sounds like he has some 'splainin to do....

The second makes a major mistake by understating the problem as only the current account deficit of $8 trillion, when the real problem is the projected unfunded liabilities, the gap between projected revenues and committed obligations as they mature. That number is north of $65 trillion.

[redgolum]

Privatization is a pipe dream because NO ONE has the cahones to stand up and tell the American people the truth: There's no money. We spent it. Sorry. You're on your own for retirement security and healthcare. That's the unvarnished truth.

When the day comes that the truth is revealed, there will be an uprising like you wouldn't believe. God save the USA.

[Toddsterpatriot]

thanks to fr

Free Republic or.......the Federal Reserve?

So what did it say? The Fed is draining all our precious bodily fluids? You never did tell me who owned the Fed or how much they profit from that ownership.

[Eagles Talon IV]

What do you suppose would happen to China's economy if they suddenly lost the American market? We are by far the worlds largest consumers and our economic demise would pull the entire world into financial ruin along with us.

Can you see oil at about $3-5 bbl? Because with about zero demand that's where it would be.

[pigdog]

The poster in question is an income tax fan and a proponent of the sort of Happy Talk we see in the Skeptical Optomist.

I've seen numbers of $75 Trillion for the unfunded liabilities - but IAE it's large than either a breadbasket OR the Eiffel Tower (or both).