The Empire Strikes Back

By John Lumbard, CFA.

We’ve just been reading comments by Establishment journalists—the LA Times, Slate, Paul Krugman of the NY Times—who raged against Time Magazine’s excellent and well-researched cover story about the federal debt .  The truth is that the dangers described by Time were minimized;  author James Grant used the $13.9 trillion figure for the “public debt” rather than the national debt clock’s $19.2 trillion, pointing out that the latter includes the trillions in U.S. Treasury bonds that have been purchased by the Fed, as well as those sitting in the Social Security and Medicare trust funds.

The ugly truth comes in two parts.  If the Social Security Administration goes to our Congress to cash in the Treasury bonds in its vaults, Congress will have to borrow the same amount from the Chinese, or somebody, to make the payment.  Or, Congress can raise taxes sharply …. In hindsight it would have been much better to have invested the Trust Funds in a normal portfolio of stocks and bonds.  We The People would have received a higher return, and the bonds in the trust funds would not be a stack of IOUs from Congress to itself.

The other issue is that the vast majority of Americans view their future Social Security checks and Medicare as a something they paid for, that is owed to them.  Generally Accepted Accounting Principles (GAAP) demand that future liabilities be treated as debt.  You see this all the time with pension liabilities, and this is no different—unless you’re willing to say that we’re going to cut Social Security and Medicare.  David Walker, the former U.S. Comptroller General, says that proper GAAP accounting would put the debt at $65 trillion or more.

President Obama spoke eloquently about the burden of the debt (go to the end of the second page, S2237) when he was in the Senate.  At the time the “public” debt was only $5 trillion, and now it’s $13.9 trillion.  Piling up that debt has been a good deal for older Americans, because for decades they’ve been paying less in taxes than they should have (or they’ve been getting too much in benefits such as Social Security, Medicare, and Medicaid).

A better way to look at the debt, then, is to assume that it’s owed by the younger half of the population.  $86,000 per person if you use the “little” $13.9 trillion figure in Time.   Sure, we’ll never have to actually pay that down to zero, but President Obama was right;  the interest payments cut deeply into the budget, and prevent us from spending on other things.  When interest rates get back to normal levels those interest payments will become painful indeed.


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