Dealing with the Government Debt Bubble

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Dealing with the Government Debt Bubble

The U.S. national debt and the Federal deficit have ballooned to alarming proportions.  According to the National Bureau of Economic Research (NBER), the Federal deficit reached an estimated $1.4 trillion in fiscal year 2009.1  This amounts to just less than 10 percent of GDP, which is the highest deficit-to-GDP ratio since 1945.

Meanwhile, the NBER reports that the Federal debt held by the public is expected to surpass $6 trillion, or about 54 percent of GDP, at the end of fiscal 2009.2   This is the highest debt-to-GDP ratio since 1955.  The total outstanding Federal debt for the year is predicted to exceed $11.8 trillion.  That's about 90 percent of GDP.

How did we get here? 

Spending has increased substantially in the past decade in order to cover new social programs like the Medicare drug supplement, as well as to finance the War on Terror.  For most of the decade, tax cuts, intended to stimulate the economy, did their jobs, helping to create a growing stream of tax revenues at the local, state, and Federal levels. 

However, when the financial crisis froze the velocity of money and crushed the housing sector, tax revenues collapsed.  This was followed by the deepest recession since the Great Depression; some $1.62 trillion was lost in the U.S. between the end of 2006 and the end of 2009.  The Federal Reserve responded by lowering interest rates to near zero as of December 2008 and followed up with quantitative monetary easing. 

The Troubled Asset Relief Program injected $700 billion into banks, while the Economic Recovery and Reinvestment Act created $787 billion in one-time government spending.  In the process, Federal spending soared by 18 percent in 2009 alone, to nearly 25 percent of GDP.  Meanwhile, government revenues in 2009 slipped 17 percent below 2008 levels to the lowest percentage of GDP in the last 50 years.  The resulting deficit, caused by higher spending and lower revenues in 2009 alone, amounted to 10 percent of GDP — the highest proportion in more than 50 years. 

As Brian Wesbury and Robert Stein of First Trust Portfolios argue in a recent Monday Morning Outlook report, this explosion in the Federal debt bears an uncomfortable resemblance to the housing bubble.  They also argue that the long-term consequences of this new bubble could be even more troubling.3

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To recap:  After the 2001 terrorist attacks led to the onset of a recession, the Federal Reserve cut interest rates and kept them too low, for too long...

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