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 “Minutes from Midnight: Growing Pressure on the Treasury Market Could Lead to Default”

According to the Compact for America Debt Default Clock, we are only minutes from midnight—that ominous hour when the federal government will face fiscal crisis, insolvency, and ultimately default. This chapter explores the twelve factors related to the Treasury securities market that are looming over the federal government and examines possible solutions to buy it time away from the brink of fiscal disaster.

The federal government’s gross debt, which includes both debt held by the public and debt held by federal government trust funds, now exceeds $21 trillion.[1] The Congressional Budget Office (CBO) projects this debt will grow to almost $34 trillion in fiscal year 2028.[2] CBO also projects that gross interest costs in the same year will exceed $1.1 trillion.[3] What’s more, CBO Director Keith Hall testified in an April 11, 2018, hearing before the Senate Budget Committee that:

The likelihood of a fiscal crisis in the United States [given the projected debt held by the public] would increase. There would be a greater risk that investors would become unwilling to finance the government’s borrowing unless they were compensated with very high interest rates; if that happened, interest rates on federal debt would rise suddenly and sharply.[4]

Dr. Hall is correct that the projected debt will be the single most important factor leading to the imposition of intense pressures on the Treasury securities market in a way that could lead to a fiscal crisis. If anything, Dr. Hall underestimates the risk both because his observation focuses on only the portion of the federal debt held by the public, as opposed to the larger gross debt, and because it is likely that a fiscal crisis, should it occur, will be followed rapidly by federal government insolvency and ultimately default. For the purposes of this chapter, default is defined as the failure by the federal government to make timely payment on a debt obligation.

Beyond the projected growth in the federal debt, there are myriad factors that contribute to the growing pressure on the Treasury securities market. Chief among them is the concomitant growth in gross federal interest costs. The Debt Default Clock initiative of the Compact for America Educational Foundation asserts that twelve factors are the most important.[5] It is the objective of the initiative to bring to the attention of the federal government’s fiscal policy makers the dangers of the growing pressure on the Treasury securities market and the likelihood it will lead to a sequence of fiscal crisis, insolvency, and default by the federal government if it remains on its current fiscal path. In essence, the Debt Default Clock is a flexible instrument for predicting both the time and circumstances of the sequence of federal fiscal crisis, insolvency, and default. It is anchored in the observation made by Dr. Hall described earlier that at some point there will be an unwillingness of investors to finance the federal debt compared to today’s more benign circumstance. The Clock depicts these emerging Treasury market conditions in minutes away from midnight, where midnight is the initiation of the sequence of federal fiscal crisis, insolvency, and default.

This is not to say that the Debt Default Clock implies that the sequence of federal fiscal crisis, followed by insolvency and default, is inevitable. It will happen only if the federal government remains on its projected fiscal path. A Review Committee updates the Clock periodically to account for either positive or negative developments regarding the health of the Treasury securities market. Therefore, avoiding such a crisis starts with the federal government’s adopting a combination of substantive fiscal policy and budget process changes that specifically serve to lessen the growing the pressure on the Treasury securities market.

Debt Default Clock Identifies Sources of Growing Pressure on the Treasury Securities Market

As a result of a June 26, 2018, forum in Washington, D.C., involving a group of experts from both the investment and fiscal policy communities, the Debt Default Clock now points to twelve important factors that contribute to growing pressure on the Treasury securities market. They are as follows:

Factor #1: There is too much debt. This is most basic factor driving up pressure on the Treasury securities market. Under the Debt Default Clock setting today, the debt held by the public is forecast to grow to over 96 percent of GDP in the final year of the budget period (2028), and the gross debt will also peak in 2028 at over 113 percent of GDP.[6]

Factor #2: There is no dollar-denominated debt ceiling in place. Currently, there is no dollar-denominated debt ceiling in place because the debt ceiling law has been suspended.[7] This maneuver imposes psychological pressure on the Treasury securities market because it codifies an assumption by federal fiscal policy makers that there is no practical limit on the level of federal debt, and it can be financed by the market essentially indefinitely.

Factor #3: Gross federal interest costs will eat up too much revenue. Under current projections, gross federal interest costs will exceed 15 percent of federal revenues later this year (2018).[8] Further, they will remain above this threshold thereafter. Investors will at some point find it disturbing that the federal government is being forced to allocate such a large share of its income to paying interest on its debt.

Factor #4: The federal government could enter an interest-cost death spiral. Bankers will tell you that they will discontinue lending money to a debtor when large amounts of the money the debtor would otherwise obtain by taking on new debt is going to pay interest on the existing debt. In the same way, Factor #4 is a strong indicator of the lack of fiscal health by the federal government. Investors will not fail to account for this lack of fiscal health in the Treasury securities market because it signifies the extent to which the Treasury is increasing its debt to cover the growing interest costs on the preexisting debt. On this basis, gross interest costs are projected to consume over 90 percent of money raised by the issuance of new debt in 2027.[9]

Factor #5: There is too much spending. Based on historical data regarding revenues (more about revenues later), it is reasonable to expect that the federal government could balance its budget if outlays were held to 17.5 percent of GDP. The problem is that in none of the years from 2000 to 2017 (the last year actual data is available) have outlays been at or below 17.5 percent of GDP.[10] In 2017, outlays were at 20.8 percent of GDP. This problem is projected to get worse. Current projections are that federal outlays will be at 23.6 percent of GDP in 2028, which is the final year of the ten-year budget period.[11] Investors already recognize that excessive federal spending is more the source of the growing fiscal problem than are insufficient revenues.

Factor #6: In relative terms, federal government resources available to finance the debt will shrink. On a consistent basis, the federal government has used its own trust fund balances to help finance the debt. The largest of these are the Medicare and Social Security trust funds. Demographic projections will cause these two fund balances to decline in the future. This means the trust funds will have less money to make available to financing the debt, and a greater share of this financing will depend on the debt held by the public. The Debt Default Clock projects that the debt held by the public will exceed 80 percent of the gross debt in 2025.[12]

Factor #7: The foreign-held debt may make the Treasury vulnerable to manipulation. Factor #7 assesses the exposure of the Treasury to manipulation of its position as a debtor by foreign entities for political reasons. Such manipulations could be intended to increase the risk of default, particularly following a successful attempt to remove the U.S. dollar as the world reserve currency. Such a manipulation is all but certain to spook private investors in the Treasury securities market. This factor is calculated on the basis of the share of the debt held by the public that is in foreign hands. Currently, the Debt Default Clock shows that foreign-held debt will exceed 50 percent of the debt held by the public in 2021.[13]

Factor #8: The current structure of the debt, from the Treasury’s perspective, may be financially imprudent. Currently, the combination of debt instruments in Treasury inflation-protected securities (TIPS), Treasury Floating Rate Bills, and other debt instruments that mature in five years or less is a bit higher than 67 percent of the debt held by the public.[14] The Treasury’s financial position is put at risk by inflation in the future because TIPS’ principal is automatically adjusted with inflation. Its financial position is put at risk by higher interest rates because the floating rate and early-maturing securities will incur higher interest costs and require refinancing at higher rates. Accordingly, the proportion of the debt in these three categories of securities is too high.

Factor #9: Federal revenues could fall too low. Obviously, Factor #9 is the flip side of Factor #5 on outlays. The circumstance for revenues, however, differs from that of outlays. Federal revenues in 2017 were at 17.3 percent of GDP.[15] As a practical matter, this is below the level necessary to achieving a balanced budget. The level for achieving a balanced budget, as for outlays, is 17.5 percent of GDP. Further, revenues will fall to 16.5 percent in 2019.[16] On the other hand, they will recover to the 17.5 percent of GDP in 2025 and exceed 18 percent before the end of the budget period.[17] This projection accounts for the enactment of “The Tax Cut and Jobs Act of 2017” (Public Law 115-97).

Factor #10: Real economic growth may be too slow to contribute to improving the fiscal position of the federal government. While not sufficient to stabilize the fiscal position of the federal government, robust economic growth is an essential part of the solution to the fiscal problem. The reason is that a larger economy, all other things being equal, will generate more revenue for the government. At a minimum, 3 percent annual real rate of growth in terms of GDP is necessary to reach a balanced budget. Currently, CBO projects that the real annual rate of growth will be 3.3 percent in 2018 but fall short of 3 percent in the years following 2018.[18]

Factor #11: Congress has set a bad precedent regarding federal default by permitting the Treasury to pursue “extraordinary measures” in the course of past budget impasses. In the past, the Treasury has resorted to these “extraordinary measures” to delay for uncertain limited times the point at which it reaches the debt ceiling and risks defaulting on a portion of its debt obligations during times of budget impasses.[19] Generally speaking, these measures involve suspending the issuances of securities by the Treasury to certain entities, such as state and local governments, Civil Service Retirement and Disability Fund, Postal Service Retiree Health Benefits Fund, Federal Employees Retirement System, and Exchange Stabilization Fund. In general terms, the Treasury acknowledges these entities are “made whole” following the budget impasses. Typically, this involves making interest payments on the securities that otherwise would have been issued. The Debt Default Clock defines default as a failure by the Treasury to make a timely payment on a debt obligation. Thus, the admission that the entities involved have to be made whole is also an admission of a failure to make timely payments—default according to the standards set by the Debt Default Clock.

Factor #12: Congress needs to scale back programmatic “mandatory spending” and eventually phase it out. Mandatory programmatic spending, which sets aside net interest payments, does not require the annual appropriation of money by Congress. Effectively, these spending programs are on autopilot. According to CBO, programmatic mandatory spending was more than $2.5 trillion in 2017.[20] It projects this spending to grow to more than $4.5 trillion in 2028.[21]

Applying these factors, the Debt Default Clock Review Committee has determined that the Clock’s minute hand now rests at four minutes from the midnight hour that initiates the sequence of federal fiscal crisis, insolvency, and default. More specifically, the Committee has assessed that where things currently stand, Factors #1, #2, #5, #8, #10, #11, and #12 buy no minutes away from midnight. Factors #3, #4, #6, and #7 buy one minute each away from midnight. The Review Committee retains the discretion to discount up to two of the factors in the course of any review. In its last review, in May 2018, the Committee chose to discount Factor #9 on revenues because this factor is projected to move in a positive direction over the course of the budget period. The Committee’s assessment is based on its fundamental belief that the sequence of fiscal crisis, insolvency, and default will stem from a breakdown in the Treasury securities market.

Buying Time: Solutions to Reduce the Growing Pressure on the Treasury Securities Market and Prevent Default

Following the logic behind the factors underlying the Debt Default Clock, federal fiscal policy makers can start now to take the necessary steps to relieve the growing pressure on the Treasury securities market. In general, this means taking the the specific steps necessary to move the Clock’s minute hand away from midnight.

Solution #1: Put the federal budget on the path to balance. Relieving the growing pressure on the Treasury securities market starts with the core component of a responsible fiscal policy, which is to put the federal government on the path to balancing the budget before the ten-year budget period ends. Continual deficits and ever-growing debt impose a heavy burden on the Treasury to attract investment dollars to finance this debt. If the federal government stays on the currently projected path regarding the debt, it is inevitable that it will find it difficult to attract these dollars. More specifically, the goals for the factors covering outlays and revenues relative to GDP set the terms for bringing the federal budget into balance. The twin goals of these two factors are to elevate federal revenues to 17.5 percent of GDP and bring spending to the same 17.5 percent of GDP. Fortunately, revenues are projected to exceed this level well before the end of the budget period. This projection comes after after accounting for the tax reform law enacted in 2017.[22] This is why the Review Committee has exercised its discretion to discount the revenue factor at this time.

Spending, on the other hand, has been well above the 17.5 percent level for a long time and is projected to outstrip overall economic growth in the years to come. By any objective standard, the bulk of the federal government’s deficit problem rests on the spending side of the ledger. If the federal government is able to constrain projected outlays to 17.5 percent of GDP by the end of the budget period, it will buy one minute away from midnight. If it achieves an actual level of outlays that is at or below 17.5 percent of GDP, that action will buy two minutes from midnight on the Clock. By meeting the applicable goals for outlays and revenues, the federal government will also advance down the path toward meeting the two goals within the factor on the size of the debt held by the public and the gross debt as a share of GDP. These goals are to reduce the debt held by the public to below 70 percent of GDP and reduce the gross debt to below 100 percent of GDP. This factor currently buys zero minutes from midnight. Prospectively, if both the debt held by the public is forecasted to fall below 70 percent of GDP and the gross debt is forecasted to fall below 100 percent of GDP during the budget period, this factor will then buy one minute from midnight. If both actually fall below the applicable thresholds, this factor will then buy two minutes from midnight. By definition, it will reduce the financing burden facing the Treasury under current projections. This cannot but help stabilize the Treasury securities market.

Solution #2: Arrest the federal government’s growing interest costs. As alarming as the continuing deficits are, the federal government’s spiraling interest costs are even worse. Two remedies are found in relation to the two factors covering the projected growth in gross interest costs. The first of these factors accounts for the fact that it is simply inadequate to assert that the government can carry its interest costs on the basis of those costs as a share of GDP. The government does not and should not count the entire national economy as the resource it can draw on to accommodate its interest costs. The much more relevant measure of the government’s capacity to carry interest costs is its level of revenue. Accordingly, the relevant factor establishes the goal of reducing gross interest costs to 15 percent of federal revenues. It currently buys one minute from midnight on the Debt Default Clock because it is below the 15 percent threshold now and will exceed the threshold only later. “Later,” however, currently means “later this year.” At that point, the factor is likely to buy zero minutes from midnight because the threshold will be exceeded. If, by contrast, there is a change in fiscal policy that results in a projection that assesses that gross interest costs will stay below 15 percent of federal revenues during the budget period, this factor will buy two minutes from midnight.

The second of the two relevant factors uses a different measure for determining the federal government’s capacity to carry interest costs: the ratio of interest costs to the amount of money brought in by the issuance of new debt. This is the appropriate way to determine whether the federal government is entering into an interest-cost death spiral because too large a share of the money raised by issuance of new debt is being allocated, at least by implication, to covering the interest on the preexisting debt. The Debt Default Clock establishes the goal of keeping gross interest costs under 70 percent of the money raised through the issuance of new debt. The current estimate is that the level of gross interest costs will exceed 70 percent of the money brought in by the issuance of new debt (in net terms) in 2023. Thus, the relevant factor now buys one minute from midnight. On the other hand, this factor will buy two minutes from midnight if the federal government is able to project that it will stay under the threshold during the budget period. In terms of both these factors related to gross interest costs, investors in the Treasury securities market cannot but help notice the spiraling interest costs and become uncomfortable with them. By the same token, meeting the two goals established by both these factors cannot but help reassure those investing in Treasury securities in terms of keeping their investments safe.

Solution #3: Restructure the federal debt. A less apparent problem to policy makers is that the debt is currently structured in a way that provides insufficient protection against both rising inflation and interest rates. In short, too much of the debt is in treasury inflation-protected securities (TIPS), Treasury Floating Rate Bills, and other securities that mature in five years or less. The factor related to the structure of the debt also points to the solution to this problem. The Treasury should move to restructure the debt by auctioning more long-term securities and scaling back on TIPS, Floating Rate Treasury Bills, and securities that mature quickly, at least in relative terms. Ideally, this change will take place ahead of the anticipated increases in inflation and interest rates. Specifically, the goal should be for the Treasury to scale back the combined total of TIPS, Floating Rate Treasury Bills, and other securities that mature in less than five years to less than 50 percent of all the debt held by the public. Regarding the Debt Default Clock, the relevant factor currently buys no minutes away from midnight. If in the future the holdings of TIPS, Floating Rate Treasury Bills, and near-term maturing debt come down, this factor will buy one minute from midnight for every five-point reduction in the percentage of the total debt held by the public represented by these categories of securities.

Solution #4: Guard against foreign manipulation of the Treasury securities market. The goal following from the factor related to foreign-held debt is to limit such debt to 50 percent or less of the debt held by the public. As noted earlier, the Clock shows that foreign-held debt will exceed 50 percent of the debt held by the public in 2021. This is the point at which this factor will buy zero minutes from midnight. Until then, it buys one minute from midnight. If things improve such that the foreign-held debt falls to less than 50 percent of the debt held by the public and projections show it will remain below this threshold for the budget period, this factor will buy two minutes from midnight.

Solution #5: Sustain real economic growth at 3 percent annually or higher. It is axiomatic that financing the currently projected federal debt will at some point become impossible if there is a stagnating economy. The goal here is to get real economic growth to at least 3 percent annually. As noted earlier, real economic growth in 2017 was 2.6 percent. Under the relevant factor, an annualized rate of growth of 3 percent or more in the last-completed fiscal year will buy one minute from midnight. This could occur in 2018 because the current projection for the real growth rate in 2018 is 3.1 percent. When coupled with the same average annualized rate of growth forecast for the ten-year budget period, it will buy two minutes away from midnight. Current projections, however, show real U.S. growth rates will fall back below 3 percent in 2019 and remain below this threshold during the remainder of the budget period. Thus, this factor currently buys no minutes from midnight.

Solution #6: Reverse the bad precedents regarding debt management now in place by suspending the debt ceiling law and permitting the Treasury to exercise the authority to engage in “extraordinary measures.” This step follows from the factors related to restoring in law a dollar-denominated debt ceiling and staying under that ceiling and prohibiting the Treasury from engaging in the use of “extraordinary measures.” The goal under the first of these two factors is to restore a dollar-denominated debt ceiling in law and keep the actual debt below that level during the budget period. This factor currently buys zero minutes from midnight because the debt ceiling law is currently suspended. In the future, this factor will buy one minute from midnight if a dollar-denominated debt ceiling is reestablished by law. It will buy two minutes away from midnight if the dollar-denominated debt ceiling is reestablished and is accompanied by a budget projection that shows that the debt will stay below this ceiling in the course of the ten-year budget period.

Regarding the second of the two relevant factors, Congress should enact a law that prohibits the Treasury from resorting to the use of “extraordinary measures” in the future. Specifically, if either house of Congress has passed such a bill during the then-current Congress at the time of a Review Committee assessment, it will buy one minute away from midnight. If such a law is fully enacted and remains on the books at the time of the applicable review by the Review Committee, it will buy two minutes away from midnight. At this point, this factor buys no minutes away from midnight.

Solution #7: Unify the programmatic budget accounts. This step follows from the factor under the Debt Default Clock covering the matter of curtailing, and eventually eliminating, programmatic mandatory spending. Contributing to excessive federal spending is the fact that large portions of that spending is procedurally separated from other accounts; therefore, all federal programmatic spending accounts need to be brought under the same stringent standard for control. This means transferring all mandatory spending accounts back to the annual appropriations process and reviewing such spending on an annual basis. Congress, by starting to take such steps now, should be able to reduce this category of spending dramatically. In fact, it should phase it out altogether. If Congress returns enough of this autopilot spending to the appropriated category so that by the end of the ten-year budget period the mandatory category is less in dollar terms than what it was in 2017, it will buy one minute away from midnight on the Debt Default Clock. If the mandatory category is projected to be phased out altogether by the end of the budget period, it will buy two minutes away from midnight. This factor currently buys no minutes away from midnight.

The Compact for America Proposes Fundamental Budget Process Reform

The solutions detailed above will not be easy; indeed, recent history teaches us that under the current budget process, taking these steps is essentially a political impossibility. The budget process must be reformed in a way that is intended to make taking the steps outlined above politically possible. This means fundamental reform that requires amending the Constitution. Essentially, this amendment needs to facilitate limitations on the size of the federal debt in a way that does not itself lead to default. Further, there needs to be a viable vehicle for advancing such an amendment to the Constitution. Both the substantive amendment and the vehicle for advancing it have been created by the Compact for America.[23]

The Compact for America proposes a viable vehicle. The Compact for America vehicle for advancing a budget process reform amendment to the Constitution uses an alternative means for amending the Constitution that fully organizes the states in the process. At the outset, the Compact for America recognized that Congress will not, and politically speaking cannot, propose an effective budget process reform amendment to the Constitution. The primary reason for this impasse is that Article V of the Constitution requires a two-thirds majority in both houses of Congress to propose amendments. The votes for this are simply not there. This was demonstrated again in early earlier in 2018, when a balanced budget amendment acquired majority support in the House of Representatives, but not the two-thirds required.[24] The reason Congress, politically speaking, cannot muster the votes an amendment requiring fundamental budget process reform—one that staves off default—is that such an amendment will at some point in the not-too-distant future require Congress to admit that it has made spending commitments to the American people it cannot keep. Breaking these promises is tantamount to political suicide. The problem with keeping them, of course, is tantamount to financial suicide. In short, the American people cannot rely on Congress to take the lead in this area.

This is why the Compact for America is using the alternative means for amendment provided in the Constitution when the Congress is either unable or unwilling to propose the amendment: The states, rather than Congress, both propose and ratify the necessary amendment. To date, the states have never utilized this option, primarily because of the legitimate concern that such an amendment process could become either a “runaway” or “do nothing” effort if not properly organized. Thus, organizing and unifying the states in such an effort has been the impediment.

The Compact for America approach resolves these concerns and improves the chance of success by organizing the participating states into a Compact by having each state enact a substantively identical law to join the Compact. Five states are already members of this Compact.[25] The Compact serves to demonstrate that the states are taking a responsible approach to amending the Constitution by making public the text of the amendment up front and locking down the rules of procedure at the amendment convention. The Compact makes for a safe, effective, and timely process for achieving fundamental budget process reform and staving off federal default.

The Compact for America’s balanced budget amendment focuses on restraining the growth in debt as the means for arriving at a balanced budget prior to a fiscal crisis and default by the federal government. What is key is that the amendment serves to limit the ability, while not denying it altogether, of the federal government to exercise an unlimited borrowing power. It does not require the federal government to balance the budget immediately or even to balance the budget every year, barring certain exceptions. Rather, it caps the debt at 105 percent of the level that exists on the date of ratification and requires the federal government to obtain the approval of the states to raise this cap in the future.

This is not only a viable approach, it will also serve to reassure investors in Treasury securities. First, it puts the federal government on a glide path to balance following its ratification. Second, the amendment is carefully structured not to generate a fiscal crisis through its own requirements. The statutory debt ceiling is currently under suspension, which sends a signal to the Treasury securities market that the federal government believes there is no such thing as excessive debt. The amendment recognizes that in historical terms the federal government got on the wrong path regarding fiscal responsibility when it sharply curtailed presidential impoundment authority through the enactment of “The Congressional Budget and Impoundment Control Act of 1974.”[26] This virtual prohibition on impoundment has caused the debt ceiling itself to increase the risk of default. A prominent example of this is the confrontation between President Obama and Congress in 2011 over the matter of raising the debt ceiling.[27] The Compact for America’s amendment avoids this problem by giving the president the authority to impound spending to the degree necessary to avoid breaching the debt ceiling, absent an approval by the states to raise it. Thus, investors in Treasury securities can rest assured that the government will not default under the debt ceiling established by amendment.

Some may argue that the instrument already in statutory law called “sequestration” already exists as a means to avoid the problem of default under the debt ceiling. Sequestration imposes across-the-board spending reductions at calculated percentages in broad categories of accounts. The central problem with sequestration is that it is too blunt an instrument. It treats all federal spending equally, when it is clearly the case that some federal spending is more in the public interest than other spending. A second problem with sequestration is that it leaves much broader categories of spending, such as entitlement spending, outside its coverage. Impoundment, a much more precise instrument, permits the president to focus on narrow accounts that represent less worthy spending and to apply unequal levels of reductions. Further, the Compact for America’s amendment leaves no programmatic spending outside the coverage of its impoundment power.

The Compact for America’s balanced budget amendment will force the unification of the federal budget. Over the last several decades, the federal budget has been Balkanized. Some accounts, such as Social Security, have been put off-budget entirely.[28] Other spending programs, such as Medicare, have been put on autopilot by exempting them from the annual appropriations process. Still others—“emergency” spending, for example—have been exempted from sequestration. The result has been that decreasing portions of the federal budget have been subject to annual review and the application of spending restraint. In reality, this Balkanization has been an abuse by Congress of the appropriations power granted to it by Article I of the Constitution. That power was granted with the intention of restraining spending, not expanding it. It is not lost on investors that the federal government cannot adopt policies consistent with fiscal responsibility when large swaths of the budget are not subject to the instruments of fiscal discipline.

The Compact’s balanced budget amendment restores a unified federal budget by defining outlays that are subject to the fiscal restraints provided by the amendment, including the application of impoundment, as coming from any source. Accordingly, no accounts are left off the table in terms of their eligibility for making contributions toward advancing the federal budget toward balance. This will send a powerful message to the investment community that the federal government has put itself back in the position of achieving a balanced budget by making such a process mathematically plausible.

The Compact for America’s balanced budget amendment will establish procedures for the enactment of tax laws that serve to make raising revenue the primary purpose of the tax system. The Compact’s balanced budget amendment includes a provision that requires a two-thirds vote in both houses of Congress to enact bills that provide new or increased general revenue tax. However, it also maintains a simple majority requirement in both houses for bills that replace the existing income taxes with an end-user sales tax, serve to eliminate existing exemptions, deductions, and credits, and raise revenues through new or additional tariffs or fees.

A purpose of this provision is to focus the federal government’s tax system more on raising revenue and less on providing special advantages to select purposes. It will serve to raise revenues in two ways: (1) reduce the loss of revenue brought about by specialized exemptions, deductions, and credits in the current system; and (2) generate greater economic growth, and therefore higher revenues, by strengthening the supply side of the economy relative the demand side.

Ultimately, this portion of the amendment is designed to reinforce investor confidence in the Treasury securities market by raising revenue without dampening economic growth. The amendment improves the likelihood of shifting the federal tax system away from taxes on income and production and toward taxes on consumption, which should spur greater economic growth. Accordingly, it will make a significant contribution toward avoiding the cycle of fiscal crisis, insolvency, and default growing out of the loss of investor confidence in Treasury securities.

Conclusion: Four Minutes to Midnight

The makers of federal fiscal policy must recognize that the Treasury securities market is just that—a market. Financing the federal debt necessarily involves attracting capital from investors. When the federal government fails to attract the necessary capital, it will be forced to operate the government on a cash-flow basis thereafter in order to avoid default. The fact is that investor tolerance for a fiscal policy that incurs ever-growing deficits, debt, and interest costs is not unlimited. The current fiscal trajectory for the federal government, if it continues, will necessarily exhaust investor patience and break the Treasury securities market. When and under what circumstances this will occur are the questions that the Debt Default Clock is designed to answer. The Clock is an invaluable tool for educating fiscal policy makers on how to avoid breaking the market and how much time they have to take the necessary steps.

It is also essential to observe, however, that the Treasury securities market operates in a political environment. Politicians can, and from time to time do, make political calculations that run contrary to market requirements. Accordingly, some in the policy community made be tempted to stiff the investors in Treasury securities by refusing to make payments to the investors in order to gain immediate fiscal relief. That is, they may actively pursue default, perceiving it be the least-harmful option for the federal government. Such a perception represents a false hope. The immediate relief achieved through default will be followed in short order by the lack of access to capital that also forces the government back to the circumstance of having to run itself on a cash-flow basis. By way of foreign examples, the governments of Greece and Argentina have made this unwise choice in recent years. Closer to home, the government of Puerto Rico has gone down this path. Much to their dismay, these governments have found attempts to battle the forces of the sovereign debt markets a fool’s errand. Clearly, the U.S. government should not follow their examples.

The minute hand of Debt Default Clock currently stands at four minutes to midnight. This means the federal government may have less time to get off the fiscal path it is currently on. On the other hand, default is not yet inevitable. What the U.S. government needs to do now is take the steps necessary to move the Clock’s minute hand in a counterclockwise direction. If it takes these steps on a gradual but comprehensive and sustained basis, it will avoid default. History demonstrates, however, that the federal government is unlikely to take these steps absent outside assistance. This is why the states need to step in to force the fundamental changes in the federal government’s budget process by proposing and ratifying the balanced budget amendment now being advanced by the Compact for America.

Meanwhile, the Debt Default Clock continues to tick toward midnight.

Baker Spring is the Chairman of the Debt Default Clock Review Committee. He is also a member of the Council of Scholars of the Compact for America Educational Foundation. The Debt Default Clock is an initiative of the Foundation. Prior to joining the Compact for America, Spring was a Fellow with the Senate Budget Committee and a National Security Policy Analyst at The Heritage Foundation.

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References

[1] Bureau of the Fiscal Service, Department of the Treasury, “Monthly Statement of the Public Debt of the United States,” August 31, 2018, https://www.treasurydirect.gov/govt/reports/pd/mspd/2018/opds082018.pdf (accessed September 11, 2018).

[2] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 87, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018). Please note that all references to years in this chapter are for fiscal years, unless noted otherwise.

[3] Congressional Budget Office, supplemental data accompanying “The Budget and Economic Outlook: 2018 to 2028,” entitled “Spending Projections by Budget Account,” line 1732, April 9, 2018, https://www.cbo.gov/about/products/budget-economic-data#3 (accessed September 11, 2018).

[4] Keith Hall, Ph.D., Director, Congressional Budget Office, “Testimony, The Budget and Economic Outlook: 2018 to 2028,” before the Senate Budget Committee, April 11, 2018, pp. 5-6, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53721-testimony.pdf (accessed September 11, 2018).

[5] A description of the Debt Default Clock is available at the initiative’s website, https://debtdefaultclock.us/debt-default-clock/ (accessed September 11, 2018).

[6] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 87, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018). The projected gross debt relative to GDP in 2028 is based on a calculation by the author using the CBO data provided in this report.

[7] Section 30301 of “The Bipartisan Budget Act of 2018” (Public Law 115-123), https://www.congress.gov/115/bills/hr1892/BILLS-115hr1892enr.pdf (accessed September 11, 2018).

[8] As noted earlier, gross interest cost projections are provided by CBO at Congressional Budget Office, supplemental data accompanying “The Budget and Economic Outlook: 2018 to 2028,” entitled “Spending Projections by Budget Account,” line 1732, April 9, 2018, https://www.cbo.gov/about/products/budget-economic-data#3 (accessed September 11, 2018). CBO also provides the revenue projections at Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 67, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018). The author used these data to calculate the ratio of gross interest costs to total revenues.

[9] Again, gross federal interest cost projections are provided by CBO at Congressional Budget Office, supplemental data accompanying “The Budget and Economic Outlook: 2018 to 2028,” entitled “Spending Projections by Budget Account,” line 1732, April 9, 2018, https://www.cbo.gov/about/products/budget-economic-data#3 (accessed September 11, 2018). CBO also provides the gross debt projections at Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 87, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018). The author used these data to calculate the ratio of gross debt in 2027 to the money raised by the issuance of new debt by dividing the gross interest cost in that year by gross debt at the end of 2027 minus the gross debt at the end of 2026.

[10] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 149, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018).

[11] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 45, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018).

[12] CBO provides projections on both the gross debt and the debt held by the public at Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 87, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018). The author calculated the portion of the gross debt held by the public in 2025 by dividing the dollar level of the debt held by the public by the dollar level of the gross debt in that year.

[13] The databases for this factor are: (1) https://www.fiscal.treasury.gov/fsreports/rpt/treasBulletin/current.htm (accessed September 11, 2018, under the heading “Ownership of Federal Securities”); and (2) https://www.cbo.gov/about/products/budget-economic-data#3 (accessed on September 11, 2018).

[14] This calculation was made by the Debt Default Clock Review Committee using data found at: Department of the Treasury, “Monthly Statement of the Public Debt of the United States,” March 31, 2018, https://www.treasurydirect.gov/govt/reports/pd/mspd/2018/opdm032018.pdf (accessed September 11, 2018).

[15] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 67, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018).

[16] Ibid.

[17] Ibid.

[18] Ibid., p. 10.

[19] For a description of these “extraordinary measures,” see Department of the Treasury, “Description of Extraordinary Measures,” March 16, 2017, https://www.treasury.gov/initiatives/Documents/Description_of_Extraordinary_Measures_2017_03_16.pdf (accessed September 11, 2018).

[20] Congressional Budget Office, “The Budget and Economic Outlook: 2018 to 2028,” April 9, 2018, p. 49, https://www.cbo.gov/system/files?file=115th-congress-2017-2018/reports/53651-outlook.pdf (accessed September 11, 2018).

[21] Ibid.

[22] “The Tax Cut and Jobs Act of 2017” (Public Law 115-97).

[23] Detailed descriptions of the Compact for America initiative, including the text of the balanced budget amendment it is proposing, are available at the following website: http://www.compactforamerica.org/balanced-budget-compact-project.

[24] The House failed to adopt House Joint Resolution 2 by the necessary two-thirds vote on April 12, 2018.

[25] These five states, in the order they joined, are Georgia, Alaska, Mississippi, North Dakota, and Arizona.

[26] Title X of “The Congressional Budget and Impoundment Control Act of 1974” (Public Law 93-344; 2 U.S.C. 621 et seq.).

[27] For a description of this impasse and the risk of federal default associated with it, see: Bob Woodward, The Price of Politics (New York: Simon and Schuster, 2012).

[28] Section 405 of Title IV of the “Congressional Budget and Impoundment Control Act of 1974” (Public Law 93-344; 2 U.S.C. 621 et seq.).

 

Pressure on the Treasury Market Could Lead to Default

4 thoughts on “Pressure on the Treasury Market Could Lead to Default

  • Avatar
    December 21, 2018 at 9:36 PM
    Permalink

    I think it would be useful to add a text box that provides detailed language of the “Compact.” Perhaps include some language from the statutes of the states that have already joined the Compact. I am also unclear on whether some key budget variables are to be redefined. For example, will debt be defined simply as debt held by public or gross debt? The reason this matters is that there are many ways to increase cash inflows without issuing debt securities and that do not improve the financial condition of the US, e.g. start a long-term care insurance program that collects premiums while beneficiaries are working but pays benefits with a long-term lag when retired. How will expenditures be defined? Will they include an increase in obligations to make future contingent payments?

    Reply
    • Avatar
      December 27, 2018 at 11:17 AM
      Permalink

      Regarding the text box, that will be easy to do from material available from the Compact website at http://www.compactforamerica.org/balanced-budget-compact-project. The only question would be how long to make this text box. Regarding the redefinition of key budget variables, the construct of the Debt Default Clock permits the Debt Default Clock Review Committee to revise the variables, as long as the revisions preserve the intention of the Clock and they are transparent. In fact, the Committee made significant changes earlier this year. Having said that, the Clock’s existing variables each define the applicable terms internally. With one exception, which is a purely qualitative variable, they follow from the data bases they rely on for the calculations. The descriptions of the applicable data bases are available at the Debt Default Clock website at https://debtdefaultclock.us/debt-default-clock/. As a general matter, the variables use the ten-year budget time horizon on a rolling basis for projections.

      Reply
  • John Merrifield
    December 26, 2018 at 4:26 PM
    Permalink

    The debt clock is a great concept, but probably some discussion/critique of the Clock would be a valuable addition to this chapter? Is the clock excessively, or insufficiently, alarmist? For example, it ‘seems’ as if huge events add mere minutes; that we could take major positive steps and still be 20 minutes from midnight?

    How would enactment of a fiscal rule impact the minute hand of the clock? Perhaps answer by running some fiscal rule proposals thru the clock. Amash? Merrifield-Poulson? Implementation?

    Reply
    • Avatar
      December 27, 2018 at 11:46 AM
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      I am open to including some discussion/critique of the Clock in the chapter, but am not certain what form this would take. Whether the Clock is excessively or insufficiently alarmist really depends on circumstances present at the time of a review by the Debt Default Clock Review Committee. The changes in circumstances, generally speaking, are derived from updates to each variable’s applicable data base or bases. In order to view the Clock from the proper perspective in terms of sensitivity, I recommend seeing 20 minutes from midnight as near to ideal for fiscal responsibility within the ten-year period. I would describe a setting between 19 and 15 minutes from midnight as grounds for medium-term steps to address the fiscal imbalances. 14 to 10 minutes from midnight warrant near-term steps. 9 to 5 minutes from midnight warrant immediate steps. Less than 5 minutes from midnight (where we are now) require urgent steps. By the way, the Default Clock Review Committee is considering a formula for translating the minutes from midnight to a real world timeline, which is applicable at the time each review revises the minutes from midnight. You are right that calculating how the enactment of a fiscal rule will effect the calculation from the Clock can be done by running the rule through the Clock mechanism. What is required is a clear definition of the fiscal rule that will be used.

      Reply

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