The U.S. 2009 deficit violates European Union rules by orders of magnitude

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Countries that are members of the European Union are not allowed to let their deficit spending exceed 3% of their country’s gross domestic product (GDP). Seven of those countries are expected to violate that by a small amount this year.

How would Obama’s 2009 U.S. budget fare under that rule? Would you believe 8.3% of GDP—almost triple the EU rule?

A deficit is the amount by which a national government’s annual spending exceeds its tax revenues. It is also the amount of additional borrowing that government must do that year, in other words, it is the amount by which the national debt will increase that year.

Air heads for Obama will say, “So what? We are not in the EU. We don’t have to comply with their rules?”

True. But we do have to abide by the laws of economics and that EU rule was adopted because of the law of economics.

The U.S. national debt was $11 trillion on 3/2/09. The U.S. GDP in 2008 was $14 trillion.

Ratios not revenues

Before I went to Harvard Business School, I was like most people. I thought large organizations like General Motors and the U.S. government were extremely strong financially because they had huge revenue streams. But at Harvard Business, I learned that financial strength is not manifest by gross revenues. It is manifest by ratios.

The current U.S.-national-debt-to-GDP ratio is $11 trillion ÷ $14 trillion = 79%. The last time that ratio was that high was during the Korean War in 1951 which was also just after the event that had run that ratio up to 120%: World War II. Graphs of the national debt as a percentage of GDP reveal that the 1951 ratio was mostly due to the gradual payoff of the World War II debt, not any run-up caused by the Korean War.

Every percent that ratio goes up makes us a weaker country financially. And does anyone still think the huge auto maker GM is a financially strong company?

I was in the Vietnam war. There were 500,000 of us in country then. That is the size of the whole U.S. Army worldwide now. The number of casualties in Vietnam was ten times higher than it is now in Iraq and Afghanistan combined. Yet the national debt to GDP ratio at the peak of Vietnam was only about 38%. During World War II, 8 million men were in uniform and the casualty total was eight times than in Vietnam. So the two relatively small current wars cannot be turned off and instantly generate significant money to pay down the national debt. When you look at the graph I linked to above, you can see that the ratio actually dropped during the Vietnam War in spite of the fact that that war was ten times bigger than the current wars.

Obama says the national debt will decline in 2010—a congressional election year. Where will the money come from to pay down the debt? It would have to come from economic growth and Congress not passing new laws to spend even more money. Will there be economic growth between now and 2010? Obama assumes there will. But assumption is the mother of all screw-ups. Are his assumptions sound or BS? According to the neutral and highly respected Congressional Budget Office, Obama’s projections are probably overly optimistic.

Obama’s economic recovery package will actually hurt the economy more in the long run than if he were to do nothing, according to the nonpartisan Congressional Budget Office. In other words, things will get worse over the next ten years, not better as Obama assumes, when he says the debt will go down after 2009. The main problem is that the federal government will borrow so much money that private citizens and businesses will be unable to borrow or will have to pay extraordinarily high interest rates to do so. This is called “crowding out.” Essentially, when the U.S. government has to borrow because of deficit spending, they elbow their way to the head of the line because of their top credit rating. Because the amounts the federal government is borrowing are so huge, there will be little loan money left for private borrowers. Lack of money to borrow retards growth which reduces government revenues which makes it impossible to pay down or even stop the growth of the debt.

In other words, there is a tipping point at which the U.S. government can never pay down the debt and it just gets larger and larger until the government cannot make the payments. Then we have some sort of armageddon.

The cost of insuring against a US government default (by buying 10-year credit default swaps against U.S. bonds) has gone up by 25 times in little more than a year. That means the market thinks the likelihood of a U.S. government bond default went up 25 times. Some wonder how CDS investors expect a private contract against default will be honored in the case of a US government default – which would be the equivalent of a nuclear explosion in the financial markets.

I appreciate informed, well-thought-out constructive criticism and suggestions. If there are any errors or omissions in my facts or logic, please tell me about them. If you are correct, I will fix the item in question. If you wish, I will give you credit. Where appropriate, I will apologize for the error. To date, I have been surprised at how few such corrections I have had to make.