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CBO Congressional Report- U.S. Could Face European-Style Debt Crisis

Posted by WARREN MOSLER on June 23rd, 2011

How about the accounts sticking to accounting.

Just in case you thought there was any hope:

But most ominously, the CBO report warns of a “sudden fiscal crisis” in which investors would lose faith in the U.S. government’s ability to manage its fiscal affairs. In such a fiscal panic, investors might abandon U.S. bonds and force the government to pay unaffordable interest rates. In turn, the report warns, Washington policymakers would have to win back the confidence of the markets by imposing spending cuts and tax increases far more severe than if they were to take action now.

U.S. Could Face European-Style Debt Crisis: Congressional Report

June 22 (AP) — The rapidly growing national debt could soon spark a European-style crisis unless Congress moves forcefully, the Congressional Budget Office warned Wednesday in a study that underscores the stakes for a bipartisan group working on a plan to reduce red ink.

Republicans seized on the non-partisan report to renew their push to reduce costs in federal benefit programs such as Medicare — the federal government health care program that benefits the elderly.

The report said the national debt, now $14.3 trillion, is on pace to equal the annual size of the economy within a decade. It warned of a possible “sudden fiscal crisis” if it is left unchecked, with investors losing faith in the U.S. government’s ability to manage its fiscal affairs.

Democrats and Republicans have been stepping up budget talks aimed at averting what could be the disastrous first-ever default on U.S. government debt. A bipartisan group led by Vice President Joe Biden tasked with reaching an agreement has not made the politically difficult compromises on the larger issues, such as changes in Medicare, or tax increases.

The study reverberated throughout the Capitol as Biden and negotiators and senior lawmakers spent several hours behind closed doors. The talks are aimed at outlining about $2 trillion in deficit cuts over the next decade, part of an attempt to generate enough support in Congress to allow the Treasury to take on new borrowing.

Biden made no comment as he departed, except to say the group would meet again on Thursday and probably Friday as well.

The CBO, the non-partisan agency that calculates the cost and economic impact of legislation and government policy, says the nation’s rapidly growing debt burden increases the probability of a fiscal crisis in which investors lose faith in U.S. bonds and force policymakers to make drastic spending cuts or tax increases.

“As Congress debates the president’s request for an increase in the statutory debt ceiling, the CBO warns of a more ominous credit cliff — a sudden drop-off in our ability to borrow imposed by credit markets in a state of panic,” said Republican House Budget Committee Chairman Paul Ryan.

The findings aren’t dramatically new, but the budget office’s analysis underscores the magnitude of the nation’s fiscal problems as negotiators struggle to lift the current $14.3 trillion debt limit and avoid a first-ever, market-rattling default on U.S. obligations. The Biden-led talks have proceeded slowly and are at a critical stage, as Democrats and Republicans remain at loggerheads over revenues and domestic programs like Medicare and Medicaid.

With Republicans insisting that the level of deficit cuts at least equal the amount of any increase in the debt limit, it would take more than $2 trillion in cuts to carry past next year’s elections. House Republican leaders have made it plain they only want a single vote before the elections.

That $2 trillion-plus goal is proving elusive. And a top Senate Democrat warned Wednesday that it would be insufficient anyway.

“While I am encouraged by the bipartisan nature of the leadership negotiations being led by Vice President Biden, I am concerned by reports the group may be focusing on a limited package that will not fundamentally change the fiscal trajectory of the nation,” said Senate budget Committee Chairman Kent Conrad, a Democrat. “That would be a mistake.”

Democratic leaders, however, held a news conference Wednesday to argue for more economic stimulus measures such as a proposal floated by the White House to extend a payroll tax cut enacted last year. The move demonstrates the continuing appeal of deficit-financed policy solutions — suggested even as warnings of the dangers of mounting debt grow louder and louder.

“We absolutely need to reduce our deficit. We know that,” said Demoratic Senate Majority Leader Harry Reid. “But economists tell us that reducing spending is only half the equation. The other half is measures to create jobs.

President Barack Obama planned to meet with House Democratic leaders Thursday to discuss the status of the deficit reduction talks. The meeting comes as Democrats want the president to rule out Medicare benefit cuts as part of any budget deal.

The White House said the meeting will address deficit reduction through a “balanced framework,” a term the White House uses to describe cuts in spending coupled with increased tax revenue.

With the fiscal imbalance requiring the government to borrow more than 40 cents of every dollar it spends, the CBO predicts that without a change of course the national debt will rocket from 69 percent of gross domestic product this year to 109 percent of GDP — the record set in World War II — by 2023.

The CBO’s projections are based on a scenario that anticipates Bush-era tax cuts are extended and other current policies such as maintaining doctors’ fees under Medicare are continued as well. The debt would be far more stable under the budget office’s official “baseline” that assumes taxes return to Clinton-era rates and that doctors absorb unrealistic fee cuts.

Economists warn that rising debt threatens to devastate the economy by forcing interest rates higher, squeezing domestic investment, and limiting the government’s ability to respond to unexpected challenges like an economic downturn.

But most ominously, the CBO report warns of a “sudden fiscal crisis” in which investors would lose faith in the U.S. government’s ability to manage its fiscal affairs. In such a fiscal panic, investors might abandon U.S. bonds and force the government to pay unaffordable interest rates. In turn, the report warns, Washington policymakers would have to win back the confidence of the markets by imposing spending cuts and tax increases far more severe than if they were to take action now.

32 Responses to “CBO Congressional Report- U.S. Could Face European-Style Debt Crisis”

  1. Art Says:

    Crap. I thought Orszag had returned to the private sector. :)

    “The report said the national debt, now $14.3 trillion, is on pace to equal the annual size of the economy within a decade. It warned of a possible “sudden fiscal crisis” if it is left unchecked”

    Right, once you’re over 90%…thanks, Carmen and Ken! What, nothing about financial repression???

    http://symmetrycapital.net/index.php/blog/2011/06/help-help-im-being-repressed/

    Reply

  2. Gary Says:

    it is infuriating how their ignorance leads the country and whole world into next Depression…

    Reply

  3. Rodger Malcolm Mitchell Says:

    I suppose the CBO believes Japan, at 200%+ of GDP, long ago ceased to exist as a nation. What a shame. I enjoyed visiting there.

    Rodger Malcolm Mitchell

    Reply

  4. Paul Says:

    So what are we seeig here today? Dollar portfolio shifting now that QE2 is ending and QE3 is off the table? Or market reacting to Uncle Ben’s comment on slowing growth? Combo play of Saudi’s dropping the price and and IEA releasing oil reserves?

    Reply

  5. MamMoTh Says:

    I would like to insist upon the importance that MMTers focus their effort on the issue of the debt/gdp ratio and fiscal sustainability.

    The crux of the problem is with the interest rates on debt. A debt/gdp ratio pf 20% at 100% interest rate is more problematic than a debt/gdp of 200% at 1% interest rate. Even if there is no solvency issue, in the former case 20% of income is risk-free economic rent whilst in the latter only 2%, and this difference has economic consequences.

    So the only issue is whether the government or the market set the interest rate on government debt. I know MMT states the government can set it in the case of a free floating currency.

    I do understand it in the sense it is an interbank interest rate maintenance operation that could be dealt with paying interest on reserves with no debt issuance. Right?

    It is not clear to me how it works under the current institutional arrangements where debt is issued and auctioned by the private sector.
    So if someone like me, no expert but quite familiar with MMT, struggles with this, how could we expect those with no economics background and no familiarity with MMT get it?

    I think this issue must be addressed in a dedicated post by someone of the MMT community. Or am I the only one feeling that way?

    Reply

    Tom Reply:

    @MamMoTh,

    yeh seems like a good thing to get a lot of detail out there on.

    Reply

    Neil Wilson Reply:

    @MamMoTh,

    The institutional arrangements try to emulate the response of a fixed rate currency. They are the problem.

    There comes a point when the ‘current institutional arrangments’ have to be dropped and something else tried instead.

    I’m seeing a lot of posts at the moment starting to wax about ‘if only the central bank was truly independent’ and other such nonsense.

    The build up of stocks of net financial assets is only appears to be a problem if they are likely to flow at some point shortly and cause inflation. Or their gravity causes concentration of power problems within politics.

    Again it is the fixation with nominal issues when the actual problem is real.

    Reply

    Tom Reply:

    @Neil Wilson,

    So MMT wise, the total national debt isnt really a problem if its: 1. not going to be spent all at once short term, and 2. spread out in many hands?

    I always wondered about that…because I understand everything regarding deficits and federal debt, but wasn’t sure if there is a point at where, from a MMT perspective, the total debt has become way too large.

    Reply

    WARREN MOSLER Reply:

    and there’s always the risk of a ‘burst of spending’ from the private sector, deficit or not, as there is risk of a sudden cessation of spending.

    goes with the territory, and that’s what fiscal/countercyclical policy comes in.

    like it should have in Aug 08…

    Reply

    beowulf Reply:

    @MamMoTh,
    The Fed goes old school and caps interest rates. As Tim Canova explained:
    Although federal spending and borrowing in the 1940s was much higher than it is today, there was no rise in interest rates. From 1942 to 1951, the Federal Reserve was accountable to democratically elected officials. It was directed by the White House and Treasury to peg interest rates at three-eighths of 1 percent on short-term Treasury borrowing and 2.5 percent on long-term borrowing. This so-called pegged period of public finance began in the weeks following the Japanese attack on Pearl Harbor. As the Federal Reserve itself would later describe the division of responsibilities, the amount of government spending was properly determined by Congress, and it was the Treasury’s responsibility to determine the rate of interest it would pay on its borrowing. It then became the Fed’s duty to purchase government securities in any amount and at any price needed to maintain the interest-rate pegs for Treasury.
    http://prospect.org/cs/articles?article=the_federal_reserve_we_need

    Reply

    Matt Franko Reply:

    @MamMoTh,
    “where debt is issued and auctioned by the private sector.”

    Can you expand on this? Are you talking about the current process of issuance of Treasury Securities? To the Dealers, etc..? How that would work while we would at the same time be paying interest on reserves? Resp,

    Reply

    MamMoTh Reply:

    @Matt Franko, yes I am talking about the current or past process of issuance of Treasury Securities, with or without interest on reserves. And I cannot expand on this, I am basically clueless about it, that’s why I am asking.

    Reply

    Matt Franko Reply:

    @MamMoTh, I’d offer this paper by Scott Fullwiler from a while back as perhaps a place to start:

    http://www.cfeps.org/pubs/wp-pdf/WP38-Fullwiler.pdf

    “With IBRBs, all Treasury securities could eventually be replaced; the interest rate on the
    national debt would then be the rate paid on IBRBs. Treasury securities themselves are simply
    fixed-rate liabilities and from the private sector’s perspective not functionally different from
    IBRBs aside from the flexible-rate nature of the latter. Note that consideration of IBRBs
    demonstrates how interest on Treasury debt is determined: with IBRBs and no securities issued,
    the interest rate is the rate paid on IBRBs; where short-term securities are issued, as above these
    rates are set via arbitrage with the Fed’s target; as longer maturities are issued, again as above
    these rates are set largely via arbitrage with the expected path of the Fed’s target
    . The “crowding
    out” view of the loanable funds market is irrelevant; the rates on various types of Treasury debt
    are set by the current and expected paths of monetary policy and according to liquidity premia on
    fixed-rate debt of increasing maturity. Since long-term rates are normally higher than short-term
    rates, total interest on the national debt would be significantly reduced if IBRBs eventually
    replaced Treasuries. Those—like the Treasury—fearful that IBRBs would reduce seigniorage
    income neglect that this would be far outweighed by the reduction in total interest paid on a
    national debt increasingly held as IBRBs. Indeed, there is no inherent reason for Treasury
    liabilities to exist across the entire term structure except as support operations for longer-term
    rates (Mitchell and Mos ler 2002).”

    MamMoTh Reply:

    Thanks Matt. Although a bit too technical I guess it’s good enough an explanation to me.

    the rates on various types of Treasury debt are set by the current and expected paths of monetary policy and according to liquidity premia on fixed-rate debt of increasing maturity.

    If we assume the paths of monetary policy follows the path of inflation, then government can set the interest rates only if it keeps inflation in check.

    I have no problem seeing why Japan is able to leave interest rates at 0% with no inflation, but what happens if inflation reaches 10%?

    WARREN MOSLER Reply:

    depends entirely on what investors think the boj will do to short term rates

    Tom Hickey Reply:

    @MamMoTh,

    Why would inflation reach 10% in any plausible scenario?

    There are two mechanisms. The first is demand-driven, with excessive effective demand due to money creation exceeding the ability of the economy to expand to accomodate it. Th second is supply shortage, e.g., an oil crisis.

    The responses have to different. Addressing the first according to MMT, involves withdrawing non-government NFA through taxation to reduce effective demand, and the second involves addressing the supply issue instead.

    The sudden fiscal crisis scenario involves bids for tsys drying up and offers mounting because the market looses confidence in the USD to government profligacy. Just exactly what would the lead up to the scenario look like in light of the experience of the US in WWII and of Japan over the past few decades, which R & R overlooks. The world is now staring in the tiger’s eyes of deflation and the tiger is getting hungrier. Is this scenario even plausible? It’s a bogeyman.

    Matt Franko Reply:

    @MamMoTh, You may also want to take a look at the 2nd video Bill has posted at the llink below from the Teach-In last year for an explanation on “inflation”.

    http://bilbo.economicoutlook.net/blog/?p=12089

    Supply shocks are not inflation. At about the 14:00 mark in the Q&A, Warren and Bill have one of the best discussions about what is really inflation. Currently we have very little to no inflation, the real threat is deflation and it looks like the Fed knows this. The chances of any real inflation in the future is next to impossible, especially if the Fed starts a new policy where they maintain a permanent near zero rate policy.

    Resp,

    WARREN MOSLER Reply:

    the fed votes on the term structure of risk free rates. it’s a simple matter of a monopolist setting price

    Reply

    MamMoTh Reply:

    @WARREN MOSLER,

    I know it is all to obvious to you, and maybe to most people familiar with MMT. But not to me, and I suspect to most people around. In if that is not clear to people, then you are doomed to fail in explaining why according to MMT the level of debt is not a problem per se.

    Reply

    beowulf Reply:

    @MamMoTh,

    IBRB = Interest Bearing Reserve Balances (had to look that one up). Treasuries are sold (draining the reserves added to bank accounts by shifting them to securities accounts) as a tool to peg a positive interest rate in the interbank Fed Funds market, otherwise the Fed Funds rate would quickly fall to zero (which is OK really, but the Fed doesn’t understand this).
    The problem is solely political, with every T-bond sale– Tsy walks ever closer to the federal debt ceiling. However the newly authorized (in 2008) IBRB provide a sort of synthetic drain. By paying interest on reserve accounts, the Fed can now peg interest rates without the sale of Treasuries. Which means that Tsy can spend new money it creates– most easily by minting coins, which the Fed buys at face value– debt-free (notice though with a positive interest rate, any drain entails interest costs).

    It is pretty disturbing to watch the Administration so badly flub problems, like the debt ceiling, that aren’t really problems. What would they do in a genuine emergency? You can’t negotiate against yourself with an asteroid.

    roger erickson Reply:

    @MamMoTh,

    The amusing concept of public fiat debt keeps coming up, showing complete semantic confusion. Progress can’t occur without accurate definition of terms.

    Conflating private and public money-creation “debt” completely undermines all that so many have worked so hard to instill, from Jefferson, Lincoln, Keynes, FDR, Marriner Eccles, Beardsley Ruml, Abba Lerner, Bill Vickrey, Robert Eisner, Wynn Godley .. on to Warren Mosler & the MMT camp.

    It is, simply, an oxymoron. By semantic definition, sole issuers of fully fiat currencies cannot possibly borrow those currencies! Hence, fiat debt is NOT a deficit or debt in any real meaning. It’s fully equivalent to an individual borrowing his own initiative – and assigning some point system to measure it.

    It really is disastrous semantics to conflate Treasury securities with borrowing.

    That simple point is the root of all confusion over money creation, which itself aids so much Control Fraud.

    Treasury securities predate leaving the gold std, whereupon they became as obsolete for money creation as taxes became for issuer “revenue”. http://tinyurl.com/y3dkda3

    T-securities were just a retained habit, that fell back to a plausible but not necessary use as a interest rate reference.

    Voluntarily linking security creation to money creation is not “borrowing” any more than is setting interest on a savings account. Even that analogy isn’t close enough, since neither private depositors nor banks are currency issuers.

    It’s truly a unique, monopoly position, as Warren keeps saying.
    A fiat currency issuer has no “debt” in it’s own currency, and it can enforce use of it’s currency if you must pay taxes in that currency. Everything else is just strategy & noise among those playing the game where $US is used on the scoreboard.

    Rodger Malcolm Mitchell Reply:

    @MamMoTh, Simple. Just stop calling it “debt” and more properly call it “total assets exchanged.”

    Dollars and T-securities are assets of equal value. The government “borrows” by creating T-securities and exchanging them for dollars, which it destroys.

    To “pay off” the T-securities, it reverses the process. It creates dollars, which it exchanges for T-securities, which it destroys.

    In each case, whatever the government receives is destroyed, so there is no net gain or loss of assets (aside from interest).

    It’s a semantic problem that has you confused.

    Rodger Malcolm Mitchell

    Peter D Reply:

    @Everybody,

    Guys, MamMoTh knows all this stuff pretty well. He has MMT in his moniker after all :)
    What he’s asking is about more clarity on how the Fed could peg the longer term interest rate in the setting where there are still institutional arrangements obliging Treasury to issue debt and inflation expectations start going up. His point is that these expectations will figure into the longer terms interest rates and force higher interest payments on debt.
    Yes, MMT says the FA does not need to issue debt at all, but that’s not the point. The point is how to prevent interest rate hike in the current institutional arrangements.

    WARREN MOSLER Reply:

    the fed just says, for example, that it has a bid at 3% for 10 year tsy secs, and will buy all the market wants to sell it.

    MamMoTh Reply:

    Thanks Peter D, that was my point. Hopefully you made it more clear than I managed to.

    Tom Hickey Reply:

    @MamMoTh,

    The rationale behind QE3 is the Fed’s switching from quantity to price. The markets knows this and agrees that the Fed can “cap interest rates.” As Warren repeats ad infinitum, the government is the currency monopolist and is therefore the price setter. As Beowulf has shown, the Fed has done this before. during WWII. There is no mystery here. Whats the problem.

    The entire issue with “too much debt” and debt to GDP ratio is the IGBC, that the interest in the debt will swamp government finances and the bond market will collapse. Scott has dealt a death blow to that in several articles.

    Rodger Malcolm Mitchell Reply:

    @MamMoTh, The only percentage to remember regarding the debt/GDP ratio is that the ratio is 100% meaningless.

    Federal debt is the total of open T-securities sold since the beginning of time. GDP is this year’s production. Might as well study an oranges/supernovas ratio.

    A bit more on this non-subject is at: http://rodgermmitchell.wordpress.com/2009/11/08/federal-debtgdp-a-useless-ratio/

    Rodger Malcolm Mitchell

    Reply

  6. Jim Baird Says:

    What always gets me is how these people can turn from reporting on what the Fed decided to set interest rates at to breathlessly speculating on how high rates will spike if the bond vigilates decide to strike, and never seem to put the two together in their mind…

    Reply

  7. Robert Kelly Says:

    Of course Paul Ryan warns…

    http://www.nationalreview.com/articles/270274/avoiding-credit-cliff-paul-ryan

    OY!

    Reply

    Tom Reply:

    @Robert Kelly,

    It is funny. Like what Rodger said above, it’s like they just ignore Japan’s existance.

    Reply

    beowulf Reply:

    @Robert Kelly,

    For the love of Benji. That guy is so incredibly irritating. We’ll see if NR accepts this comment. :o)

    Not to switch metaphors in midstream, but I’m afraid Paul Ryan gets lost in the Uncanny Valley on his way to a Credit Cliff to the 21st Century.

    “(like the austerity program that has provoked riots in Greece)”
    Greece surrendered its sovereign credit when it joined the Eurozone. We don’t and never will have German bankers straightjacketing our monetary, fiscal and trade policies. Since the Fed has the power to buy up Treasuries at will at any interest rate it sets, we will never be Greece.

    “Our government’s troubling reliance on foreign creditors has left us especially vulnerable to an abrupt loss of confidence.”
    We have foreign creditors because we pay for our imports in dollars. Since we run chronic trade deficits, our trading partners can either park the money in Fed reserve accounts or buy T-bonds to park the money in Fed securities accounts. So long as our trade partners like China accept our dollars in exchange for their goods and services, they aren’t going anywhere. Even if they DID stop taking dollars, we could adjust instantly but their jobs would be headed to Vietnam.

    “As Warren Buffett said, “There’s no way you can bet against America and win.””
    Ryan’s speechwriters should be careful about quoting people who are still alive. Buffett was in the press recently with something a little more, err, on topic:
    “Buffett says the U.S. will not ‘have a debt crisis of any kind as long as we keep issuing our notes in our own currency’.”

    Reply

    Robert Kelly Reply:

    @beowulf,
    Every once in a while I feel bold and drop a comment into NR or Ricochet. It’s like trying to talk hockey in a gay bar. Alas, it must be done!

    Reply

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