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.

[Toddsterpatriot]

Pick what you like and then we can talk about it.

But...but....facts are hard. Feelings are so much easier. LOL!

[capitalist229]

Our debt to GDP ratio is almost 7%.

If the world wants to continue lending us money, why should we care ?

Do you think that they can come to claim our assets ? We wouldn't even let China buy Occidental !

The worst case is a declining standard of living and bankruptcy for those who are in over their heads.

BUMP

[Paul Ross]

Perhaps a few years down the road should China decide to attack Taiwan - or the US for that matter, we can subcontract all of our war materials production to China who has absorbed so much of our manufacturing ability. It's a comforting thought, and maybe we can just wash their cars in return to pay for all the planes, munitions, etc.?

They already produce all of our super-magnets, a technology we invented just some 26 years ago, and only successfully commercialized some 17 years ago... and they are also producing 60% of all the dynamite our military needs for its bombs.

Here is an article which points up some rather egregious facts about defense dependency for the blind free trade practioners:

Eroding U.S. Industrial Base Comes With Price
By: Diane Grassi, Sierra Times, February 9, 2006

The United States of America has historically enjoyed self-sufficiency in times of both war and peace but in order to better assess its present place in the world as concerns its military and economic strength, it is important to reflect on its foundation. There is daily talk from Wall Street to Capitol Hill with respect to spread sheets and global policy, but it perhaps falls short when it comes down to addressing the average U.S. wage earner, and how both will ultimately affect jobs and the country’s national security and defense.

It is important to note, that as our forefathers were fighting for independence from England during the Revolutionary War, seldom do we hear about the underlying and overwhelming task they endured in order to supply an army without an industrial base. In order for success, the Colonies depended upon France and the Netherlands for everything from blankets and clothing to gunpowder, muskets, munitions, and food. Benjamin Franklin bartered a deal with France to ship across the Atlantic Ocean by way of the Netherlands’ St. Eustatius Island, in order for George Washington and his troops to have the means to defend themselves.

In light of the French Revolution at the turn of the 18th century, when the Netherlands were seized by Napoleon and President John Adams came close to war with France, a primary U.S. ally just years earlier, self –sufficiency was the order of the day. In 1791, Alexander Hamilton, the first U.S. Secretary of the Treasury, was asked by President George Washington and the U.S. Congress to officially document U.S. policy on industrial and military self-sufficiency. It read, “Not only have the wealth, but the independence and security of a country, appear to be materially connected with the prosperity of manufactures. Every nation, with a view to those great objects, ought to endeavour to possess within itself all the essentials of national supply. These comprise the means of subsistence, habitation, clothing and defense. The possession of these is necessary to the perfection of the body politic: to the safety as well as to the welfare of the society.”

The Industrial Revolution of the 19th century secured the U.S.policy of self-sufficiency, transforming it into a global power. Due to the strength of its industrialization the U.S. was able to defeat its enemies in World War I. With the advent of the automobile, which Henry Ford learned to mass-produce, weaponry and machinery produced for World War II benefited from the automobile factory. Production of Sherman tanks, Army jeeps, airplanes and PT boats evolved from such civilian U.S. factories. And in the 1950’s the industrial base was modernized for the Korean War effort.

The industrial base and manufacturing for the U.S. military were necessarily intertwined. But following the end of the Cold War there has been a deliberate decomposition of U.S. industry, unprecedented in American history. There are a number of factors which have contributed to U.S. dependence on foreign trade, primarily with India and China, which has not only led to millions of U.S. manufacturing and engineering jobs permanently lost, but paints a grim picture for the long term stability of the U.S. military supply line.

The dependence on foreign oil and the subsequent OPEC oil embargo in the 1970’s, the U.S. policy of deregulation of corporations of the 1980’s, the passage of the North American Free Trade Agreement (NAFTA) in 1994, and the World Trade Organization (WTO) in 2001 allowing China to become a member, collectively accelerated U.S. dependence on cheap labor offshore. Thus, dependency and reliance on suppliers from all over the world for military equipment and machinery components and parts, required for their manufacture, leaves the U.S. vulnerable.

The Defense Department runs a program called the Diminishing Manufacturing Sources and Materials Shortage (DMSMS) at the Tank Automotive and Armaments Command (TACOM). Its purpose is to identify shortages of parts, processes and materials necessary to procure for military buyers. A problem for military acquisitions has been procuring weapon system metal castings as a direct result of plant closings. The majority of castings now come from China and other third-world countries. Along with the foreign dependence on metal castings manufacture, its research and development also followed the foundry industry offshore.

DMSMS program managers are aware that there are problems in finding sub-parts and components. Not only have replacement parts started to rapidly diminish, but the chemicals needed in their manufacture have as well. Without specific chemicals certain processes cannot be done. For example, there is only one company left in the U.S. that produces a roller cutter for armored plate or heavy steel which was an indirect consequence of supplying armor kits for U.S. Humvees for the War in Iraq. When the Pentagon learned there was an immediate need at the end of 2004, it called for expediency in their manufacture. Sadly, it took almost a year due to the limited facilities producing such.

Another issue arose when a foreign corporation purchased the only U.S. company which produced a chemical used for a common binder which secures windows and aluminum panels in aircraft. The company eventually folded when it could not meet Occupational Safety and Health Administration (OSHA) and Environmental Protection Agency (EPA) standards. Now the U.S. must depend on the company’s offshore subsidiaries.

Similarly, the bearing industry which produces ball-bearings, roller-bearings and anti-friction bearings is an endangered U.S. industry, key to the production of military gear and plays a part in homeland security. They are components necessary to produce electric motors for conveyor belts such as in factories, steel mills, in airports, in mining, and with the equipment used to manufacture automobiles. And bearings are critical to the mechanical components of major weapons systems. Losing bearings manufacturing to foreign shores directly impacts the capabilities of weapons manufacturing should there be a change in the geopolitical landscape and a cut-off from U.S. suppliers, whether through war, terrorism, or Mother Nature.

With the military build-up of China over the past decade by benefit of applying commercial technologies to military weaponry and its having become the largest offshore manufacturing base for U.S. corporations, the U.S. continues a delicate balancing act with a Communist nation as its biggest trade partner. With a U.S. trade deficit with China reaching over $200 billion in 2005, multi-national corporations, once U.S. companies operating in the U.S., are now just based in the U.S.

And with a demand by China for foreign direct investment as its incentive to buy U.S. products, companies like Boeing are acquiescing by not only building major portions of airplanes in China, but also creating Research and Development opportunities for Chinese engineers, in order to show its commitment. Intel and Microsoft have also followed suit with major investment in directly hiring engineers in China.

Endless conflicts of interest abound when it comes to foreign dependence in order for the U.S. to maintain its infrastructure, electrical grid, military weaponry and supplies, air travel and homeland security, to name a few. When smaller U.S. specialty industries vital to the industrial base become extinct on our shores, they now appear huge in a world where alliances are tenuous at best. A global economy at the expense of U.S. sovereignty, security and standard of living is something that the Colonists would not have stood for. They would have found another way. Maybe America still has time to do the same.

[Larry Lucido]

Is the United States Bankrupt?

I was just down at bankruptcy court and didn't see it there. Maybe it has a different court date.

[Larry Lucido]

Not arguing with your formula, but how do you determine the net worth of a country?

[napscoordinator]

Morally - perhaps. Financially - no.

[pigdog]

I certainly do not agree that it is good to see our manufacturing base being drained away and that is precisely what is happening with China's (and other countries') efforts.

You seem a lot more certain than I am that entitlements are going to magically straighten themselves out. I see no evidence at all of that and in fact all I've noticed is endless yammering and hand-wringing in Congress about "somethings gotta be done" - while doing nothing.

And it isn't crazy that the payroll w/h for S/S have been taken and spent by our drunken-sailor government and are now merely IOU's that can't be paid. The continual rollover of debt as a solution accomplishes little but adding to government's costs ... and who is it who at some point will have to bear those costs???

I'm certainly not of the persuasion that "debt doesn't matter since it can always be refinanced" into the future. Eventually that fails. So I don't see that trying to find a reasonable solution is taking anything out of focus. There are a lot of eminent economists who believe that also.

I don't take the term "bankrupt" as literally as you seem to, but I certainly see no "simpler options" that can offer the benefits that the FairTax does. And apparently neither does Congress since none have been offered up successfully in several decades (or generations, even). But even if they made a serious attempt to do so it's unlikely they'd be successful without dramatic change - the goodies are just too embedded into the consciousness of too many who do not contribute to the tax rolls - and yet want even more at taxpayer expense.

There's nothing that I find crazy at all about trying to find a solution to the entitlement funding problem to give us some time to find ways to get rid of it completely (hopefully). Boldly stating that "no way in hell is America going bankrupt" is going to change anything. With our manufacturing going away as rapidly as it is and many of our jobs being "outsourced", America has little to say about it unless we make some significant and major changes in how we do things overall. A bit of tinkering with taxation here and there hasn't worked well in almost 100 years and certainly is not likely to do so now. Major changes are on the horizon and I'd prefer to see us make them instead of having hem foist upon us by other countries.

It's time for the FairTax!!!

[Paul Ross]

Our debt to GDP ratio is almost 7%. If the world wants to continue lending us money, why should we care ?

Because it is a serious problem. Not lightly waved away, despite facile assertions to the contrary.

"I place economy among the first and most important virtues, and public debt as the greatest of dangers. To preserve our independence, we must not let our rulers load us with perpetual debt."

-Thomas Jefferson

Do you think that they can come to claim our assets ?

China already "claimed" the Asset of Magnequench and relocated it to Tianjin, lock stock and barrell...all four plants, history.

We wouldn't even let China buy Occidental !

Just barely averted, the Administration was all geared up to defend this with its CFIUS Committee (you know, the Treasury-Dept. dominated schills who only worry about expediency and balancing the books: "National Security? How do you enter those into our books? You can't? Good, then we can ignore it....).

[pigdog]

Quite so!! Good post.

[Paul Ross]

I was just down at bankruptcy court and didn't see it there. Maybe it has a different court date.

Maybe it has a different venue than your personal region. Better check PACER. LOL!

[pigdog]

Quite possibly. And the fact you don't see it yet metaphorically does not mean you won't at some point within your lifetime.

[expat_panama]

how do you determine the net worth of a country?

You nailed it --this is the key.  

Net worth is assets minus liabilities.  We got lots of good numbers on public debt which is currently (from here) $8,413,248,232,387.89.  It's the assets that get people messed up. We can't count expected revenue because that's income and not assets. 

We can start with 900,270,200 acres of government land and if it's worth $9,345 per acre then our net worth is zero.  If we add in the physical capital assets like buildings, then we know we can get a higher number.  From just '62 to '95 alone we've spent $4,204,249,000 on that stuff.  Real estate values have gone up.  How about the gold in Fort Knox?  Where we stop is when we look at the really good stuff (from this link):

The Government owns significant amounts of land and mineral deposits. There are no official estimates of the market value of these holdings (and of course, in a realistic sense, many of these resources would never be sold....  ...These estimates omit some valuable assets owned by the Federal Government, such as works of art and historical artifacts partly because such unique assets are unlikely ever to be sold and partly because there is no comprehensive inventory or realistic basis for valuing them.

The bottom line on "net worth" (pun intended) is that the US government is not a business, not supposed to be a business, and it's not supposed to have a net-worth and it will not go bankrupt.

[Larry Lucido]

Good post. I would add that for any entity, future income stream does increase its value. A goose that lays golden eggs is worth more than a goose that doesn't. Unless you cook it first. :-)

[ancient_geezer]

Buy gold!!

Why would I do that? Gold doesn't pay interest or dividend, nor can it be said to be worth anything as an appreciable asset.

Better to create or invest in a business than buy gold anyday.

Unfortunately, people are using less and less of their income dollars to do the latter for the strong disincentives of high marginal tax rates on savings and investing as well as inflationary expectations.

As the savings rate with respect to discretionary income more than apply demonstrates. In fact they have begun to actually head into negative territory as a savings rate. The are becoming net debtors instead of net investor/savers of income.

 

[expat_panama]

You seem a lot more certain than I am that entitlements are going to magically straighten themselves out....  ...our drunken-sailor government...   ...IOU's that can't be paid...   ...bear those costs???  ...our manufacturing going away...   ...our jobs being "outsourced"...  ..I certainly see no "simpler options" that can offer the benefits that the FairTax does.

OK, so we're doomed without the Fairtax. 

Over a hundred years ago the US Supreme Court ruled that the federal government did not have the authority to levy a national sales tax.  Same thing happened with the income tax but they managed to amend the constitution.   We need to get serious and see that the fairtaxers don't stand a chance. 

Hey, we're still not doomed even if "those costs???" grow clear into "those costs???????????????????????????????".  There are an infinite number of solutions.  You say you can't see any.  Either you aren't clever or you haven't tried.  Here's just one: personal retirement accounts for younger workers, let young people use personal retirement savings accounts. set aside $2.4T for seniors, raising retirement age.  More here.

But hey, go ahead and spend your energy on your fairtax if you really want.  We got plenty of time to consider lots and lots of ideas because in all honesty our nation is simply not on the brink of doom. 

Try not to take too long though...

[expat_panama]

... future income stream does increase its value.

When it comes to the American republic you're absolutely right.  Private America's ability to create wealth seems to be the best kept secret on this "respected conservative" thread.  So we got an $8 trillion national debt. Big deal.  We've created that much wealth (after paying debts) in just the past two years.

Doomers are idiots.

[ancient_geezer]

Over a hundred years ago the US Supreme Court ruled that the federal government did not have the authority to levy a national sales tax. 

You care to cite that ruling so we can review said case?

[Larry Lucido]

Better check PACER. LOL!

LOL! PACER is always at least a week behind!

[ancient_geezer]

So we got an $8 trillion national debt. Big deal. 

 

I see you missed the unfunded $65.9 trillion fiscal-gap laying in commitments this government has signed us all and our children on to.

That my blind friend is a "Big deal.", and one that does not just go away by your choosing to ignore it.

[pigdog]

I doubt the government can or will spend much of its "net worth". The tax income generated, however, CAN be spent (and even overspent).

So your belief is that tax revenue can be made to increase in an ever-growing amount keeping the "wolf from our door", eh??? Great idea but it hasn't worked too well in many different countries over history and it's hard to see why you think the US is different than all of those? Perhaps because "it's us"? I'm afraid hat's not a very strong argument. every country that has ever existed has had one of more cataclysmic economic upheavals in its history while we - so far - have been relatively unscathed. There's no reason to think this would continue forever ... or is it because our currency is green???

The only hope of your scenario playing out over a long term is for those controlling the money supply continuing to inflate the economy overall steadily a bit at a time - as Beardsley Ruml said. It's very likely that some external force will eventually disrupt that delicate balance and should that happen (which in history it always has) things will be very sticky indeed. You don't seem to be aware that almost every country has "gone bankrupt" during its existence and some are no longer around.