Introduction
The United States public debt is the money borrowed by the federal government of the United States at any one time through the issue of securities by the Treasury and other federal government agencies. The US national public debt consists of two components:
- Debt held by the public comprises securities held by investors outside the federal government, including that held by investors, the Federal Reserve System and foreign, state and local governments.
- Intragovernment debt comprises Treasury securities held in accounts administered by the federal government, such as the Social Security Trust Fund.
The public debt increases or decreases as a result of the annual unified budget deficit or surplus. The federal government budget deficit or surplus is the cash difference between government receipts and spending, ignoring intra-governmental transfers. However, there is certain spending (supplemental appropriations) that add to the debt but are excluded from the deficit. Debt held by the public is important because it reflects the extent to which the government goes into private credit markets to borrow. Such borrowing draws on private national saving and international saving, and therefore competes with investment in the nongovernmental sector (for factories and equipment, research and development, housing, and so forth). Large increases in such borrowing can also push up interest rates and increase the amount of future interest payments the federal government must make to lenders outside of the United States, which reduces Americans’ income. By contrast, intragovernmental debt (the other component of the gross debt) has no such effects because it is simply money the federal government owes (and pays interest on) to itself.
History of US Debt
The United States has had a public debt since its founding in 1791. Debts incurred during the American Revolutionary War and under the Articles of Confederation amounted to $75,463,476.52 on January 1, 1791. From 1796 to 1811 there were 14 budget surpluses and 2 deficits. There was a sharp increase in the debt as a result of the War of 1812. In the 20 years following that war, there were 18 surpluses and the US paid off 99.97% of its then debt.
Another sharp increase in the debt occurred as a result of the Civil War. The debt was just $65 million in 1860, but passed $1 billion in 1863 and reached $2.7 billion by the end of the war. During the following 47 years, there were 36 surpluses and 11 deficits. During this period 55% of the national debt was paid off.
The next period of major increase in the national debt took place during World War I, reaching $25.5 billion at its conclusion. It was followed by 11 consecutive surpluses and saw the debt reduced by 36%.
Social programs enacted during the Great Depression and the buildup and involvement in World War II during the F.D. Roosevelt and Truman presidencies in the 1930s and '40s caused the largest increase — a sixteenfold increase in the gross public debt from $16 billion in 1930 to $260 billion in 1950. When Roosevelt took office in 1933, the national debt was almost $20 billion; a sum equal to 20 percent of the U.S. gross domestic product (GDP). During its first term, the Roosevelt administration ran large annual deficits between 2 and 5 percent of GDP. By 1936, the national debt had increased to $33.7 billion or approximately 40 percent of GDP. Gross debt relative to GDP rose to over 100% to pay for WWII.
After this period, the growth of the gross public debt closely matched the rate of inflation, tripling in size from $260 billion in 1950 to around $909 billion in 1980. Gross debt in nominal dollars quadrupled during the Reagan and Bush presidencies from 1980 to 1992. The net public debt quintupled in nominal terms. Gross debt relative to GDP declined after WWII, then rose during the 1980s as part of Reaganomics. During the 1970s, debt held by the public declined from 28% of GDP to 26% of GDP. During the 1980s, it rose to 41% of GDP.
In nominal dollars the net public debt rose and then fell between 1992 and 2000 from $3 trillion in 1992 to $3.4 trillion in 2000. During the 1990s, debt held by the public rose to 50% and then was reduced to 39% by the end of the decade.
During the presidency of George W. Bush, the gross public debt increased from $5.7 trillion in January 2001 to $10.7 trillion by December 2008. Under President Barack Obama, the debt increased from $10.7 trillion in 2008 to $14.2 trillion by February 2011. Debt relative to GDP rose due to recessions and policy decisions in the early 21st century. From 2000 to 2008 debt held by the public rose from 35% to 40%, and to 62% by the end of fiscal year 2010
Debt ceiling
Under Article I Section 8 of the United States Constitution, Congress has the sole power to borrow money on the credit of the United States. From the founding of the United States until 1917 Congress directly authorized each individual debt issuance separately. In order to provide more flexibility to finance the United States' involvement in World War I, Congress modified the method by which it authorizes debt in the Second Liberty Bond Act of 1917 Under this act Congress established an aggregate limit, or "ceiling," on the total amount of bonds that could be issued.
The current debt ceiling, in which an aggregate limit is applied to nearly all federal debt, was substantially established by Public Debt Acts passed in 1939 and 1941. The Treasury is authorized to issue debt needed to fund government operations (as authorized by each federal budget) up to a stated debt ceiling, with some small exceptions.
The process of setting the debt ceiling is separate and distinct from the regular process of financing government operations, and raising the debt ceiling does not have any direct impact on the budget deficit. The US government proposes a federal budget every year, which must be approved by Congress. This budget details projected tax collections and outlays and, if there is a budget deficit, the amount of borrowing the government would have to do in that fiscal year. A vote to increase the debt ceiling is, therefore, usually treated as a formality, needed to continue spending that has already been approved previously by the Congress and the President. The Government Accountability Office explains: "The debt limit does not control or limit the ability of the federal government to run deficits or incur obligations. Rather, it is a limit on the ability to pay obligations already incurred." The apparent redundancy of the debt ceiling has led to suggestions that it should be abolished altogether.
Since 1979, the House of Representatives passed a rule to automatically raise the debt ceiling when passing a budget, without the need for a separate vote on the debt ceiling, except when the House votes to waive or repeal this rule. The exception to the rule was invoked in 1995, which resulted in two government shutdowns.
When the debt ceiling is reached, Treasury can declare a debt issuance suspension period and utilize "extraordinary measures" to acquire funds to meet federal obligations but which do not require the issue of new debt. Treasury first used these measures on December 16, 2009, to remain within the debt ceiling, and avoid a government shutdown, and also used it during the debt-ceiling crisis of 2011. However, there are limits to how much can be raised by these measures.
The debt ceiling was increased on February 12, 2010, to $14.294 trillion.[39][40][41] On April 15, 2011, Congress finally passed the 2011 United States federal budget, authorizing federal government spending for the remainder of the 2011 fiscal year, which ends on September 30, 2011, with a deficit of $1.48 trillion,[citation needed] without increasing the debt ceiling. The two Houses of Congress were unable to agree on a revision of the debt ceiling in mid-2011, resulting in the United States debt-ceiling crisis. The impasse was resolved with the passing on August 2, 2011, the deadline for a default by the US on its debt, of the Budget Control Act of 2011, which increased the debt ceiling but established several complex mechanisms to reduce public debt, including the creation of the United States Congress Joint Select Committee on Deficit Reduction and the requirement for vote on a Balanced Budget Amendment.
Credit rating downgrade, 2011
Main articles: United States federal government credit-rating downgrade, 2011 and August 2011 stock markets fall
On August 5, 2011, after Congress voted to raise the debt ceiling of the United States federal government, the credit rating agency Standard & Poor's downgraded the credit rating of the United States federal government from AAA to AA+. It was the first time the US had been downgraded since it was originally given a AAA rating on its debt by Moody's in 1917. According to the BBC, Standard & Poor's had "lost confidence" in the ability of the United States government to make decisions. The United States Treasury, political figures from both parties in the United States including the Obama administration, Mitt Romney, Michele Bachmann and John Kerry, billionaire Warren Buffett and Nobel Memorial Prize winner Paul Krugman criticized the move.
Together with the budget deficit, the political climate at the time was one of the reasons given by Standard & Poor's to revise the outlook on the US sovereign credit rating down to negative on April 18, 2011. Standard and Poor's downgraded the credit rating by one notch from AAA to AA+ on August 5, 2011, for the first time ever. The long-term outlook is negative and it could lower the rating further to AA within the next 2 years. The downgrade was met with severe criticism from the Obama administration, commentators, and other political figures. The US still has a AAA rating from other ratings agencies.
Background of American Debt Crisis
The financial debt crisis of America, as is known has been prompted by an insolvent banking system. Many economists consider the current debt crisis to be the worst financial crisis since the Great Depression of the 1930s. Although many sources have been suggested for the reasons behind, this economic period has often been referred to as "the Great Recession" by leading economists. the background of US debt crisis, it is seen that large inflows of foreign funds along with low interest rates had generated easy credit conditions for a number of years earlier to the crisis. This encouraged debt-financed consumption, while bringing a boom in housing construction. Loans of various types were easily available to get. Such financial innovations led to the institutions and investors around the globe to invest in the U.S. housing market. The disintegrating of the global housing bubble, which hit the highest point in the U.S. in 2006, plummeting the values of securities tied to real estate, thus damaging financial institutions globally.
With the decline in the housing prices declined, major financial institutions across the world that had borrowed and invested heavily in US reported major losses. The damaged confidence of the investor had an impact on global stock markets. With constant decline in credit availability, there were important questions regarding bank solvency. Late 2008 and early 2009 saw large losses in securities. International trade declined as credit tightened, while eroding the financial strength of banking institution. Governments and central banks countered the problem with unique fiscal stimulus, monetary policy expansion, and institutional bailouts. The background of American debt crisis reveals that while the housing and credit bubbles grew, a series of other factors caused the financial system to both inflate and become increasingly flimsy. Policymakers failed to identify the increasingly important role of financial institutions such as investment banks and hedge funds. Although these institutions had become as important as commercial banks in providing credit to the U.S. economy but they were not subject to the same set of laws. Assuming large debt burdens while providing the loans, they did not have a sufficient financial support to absorb the large loan defaults and losses. The Governments came forward to their rescue by implementing economic stimulus programs, and thus assuming major added financial commitments.
Causes of American Debt Crisis
There are series of factors which were the main causes of American debt crisis. American have been actively encouraged to borrow by the financial deregulation policies of both central banks and governments, the impact of a collapsing credit bubble echoed around the globe, hurting the poorest most.
· Expansion of the housing bubble
The prices of the typical American house increased by 124% between 1997 and 2006. This encouraged quite a few homeowners to refinance their homes at lower interest rates, and take out second mortgages secured by the price appreciation. Although this collection of money roughly doubled in amount, income generating investments were not able to grow as fast. By 2003, the supply of mortgages initiated at traditional lending standards had been worn out. Continued strong demand for MBS and CDO began to drive down lending standards, and soon it was difficult to sustain this speculative bubble. By 2008, there was a decline of over 20% in the average U.S. housing prices.
· Simple credit conditions
From 2000 to 2003, the Federal Reserve lowered the federal funds rate from 6.5% to 1.0% to reduce the effects of the disintegration of the dot-com bubble. These lower interest rates encouraged borrowing. The USA's high and rising current account deficit further pressurized to lower the interest rates as US required to borrow money from overseas. This developed a demand for different types of financial assets, thus raising the prices of those assets while reducing the interest rates.
· Sub-prime lending
2004-2006 saw a dramatic increase in U.S. Sub prime lending. Borrowers with weak credit histories with a greater risk of defaulting loan than prime borrowers, made good use of the easy credit condition. This higher-risk lending also became one of the main causes of American debt crisis.
· Predatory lending
Another of the reasons for American debt crisis was predatory lending, which refers to the practice of dishonest lenders, to enter into "risky" loans for improper purposes. This resulted in negative amortization, which the credit consumer might not observe until long after the loan transaction had been accomplished. There is growing confirmation of such mortgage frauds to be a cause of the debt crisis.
· Deregulation
Critics have debated that the regulatory framework did not keep up to the mark with financial advancements. The shadow banking system, derivatives and off-balance sheet financing were not given due importance. In many cases, laws were altered and enforcement made weak in parts of the financial system. Regulators and accounting standard-setters permitted the depository banks such as Citigroup to shift important amounts of assets and liabilities off-balance sheet into complex legal entities. These were among the main causes of American debt crisis
· Over-leveraging
During the years preceding the crisis, the U.S. households and financial institutions became increasingly indebted and thus adding to their susceptibility to the collapse of the housing bubble, this only led to worsen the following economic downturn. Reports reflect how the free cash used by consumers from home equity extraction doubled from 2001 to 2005 as the housing bubble expanded. This is looked upon as one of the several reasons for American debt crisis.
· Complexity in financial modernization
Use of the financial innovations like the adjustable-rate mortgage, collateralized debt obligations, credit default swaps and mortgage-backed securities expanded dramatically in the years thus, becoming the leading causes of American debt crisis. Varying in complexity plus the ease with which they can be valued on the books of financial institutions also had the effect of circumventing regulations.
· Inaccurate pricing of risk
Another of the reasons for American debt crisis is that for different explanations, market participants did not precisely evaluate the risks intrinsic with financial innovations like MBS and CDO's. They failed to gauge its impact on the overall strength of the financial system. These practically unthinkable, losses had dramatic impacts on the balance sheets of banks across the globe, which were left with very little funds to continue their operations.
Global Effects of Debt Crisis
The global effects of debt crisis could deepen if the crisis continues, according to some economists and financial experts. The economic recession could turn worse. There are fears of a global economic collapse although there are many cautiously optimistic forecasters now.
All over the world, the current debt crisis is likely to give way to the biggest banking shakeout ever. 2008 saw a clear global recession and debt crisis, which was unlikely to recover for at least two years. Economists soon announced that the end of the crisis had begun. The world started to take the essential actions needed to fix the debt crisis. There were capital injection by governments and the interest rates were cut down to help borrowers. Let us take a look into the global impact of debt crisis.
With the world's central banks lowering down interest rates, the United Kingdom govt. had started systemic injection, emphasizing the United States too to apply systemic injection. Although, the economists feel that these are only temporary solutions with the worst still to come. Their expected durations would last for two quarters in Eurozone's, while in the US it will last for three quarters. United Kingdom's duration for recession is supposed to last four quarters. It is important to note that the economic crisis in Iceland involving all three of the country's major banks, has suffered the largest banking collapse by any country in economic history.
As per the Brookings Institution reports, the US economy has been using and borrowing too much for years. The rest of the world depends on the U.S. consumer as a source of global demand. With a recession and debt crisis in U.S., there has been a dramatic decline in growth elsewhere. Germany experienced 14.4% rate of decline and Japan witnessed 15.2%. The decline rate was 7.4% in the UK, .8% in the Euro area, 21.5% for Mexico and 18% in Latvia,
The global effects of debt crisis could be seen in some developing countries that witnessed significant slowdowns after seeing strong economic growth. For example, Cambodia showed a fall from more than 10% in 2007 to zero in 2009. Kenya could achieve only 3-4% growth in 2009, while it was 7% in 2007. Drops in trade, commodity prices, investment and remittances sent from migrant workers have felt the global impact of debt crisis.
Conclusion
The scenario and future of debt crisis reflects that the budget deficits will continue to grow up in the next decade. According to Richard Duncan, author of “The Dollar Crisis”, the deficits will eventually reach an unsustainable level which may result in an economic collapse. In June 2009, a string of regulatory proposals were introduced By U S President Barack Obama as long term responses to debt crisis. These proposals deal with consumer protection, executive pay, bank financial requirements and long-drawn-out regulation of the shadow banking system. These long term responses to American debt crisis also cover improved authority for the Federal Reserve to safely wind-down systemically important institutions. Additional regulations were brought in place to limit the ability of banks to engage in proprietary trading. On the domestic side, spending for entitlements, especially for the giant health insurance programs Medicare and Medicaid has continued to grow at percentage rates that are far above inflation and far above what is sustainable. An aging population and the first waves of retirement by the Baby Boom generation are compounding the rate of growth. The inability of either government or private industry to gain control of health care costs may well be the single most critical factor in the burgeoning national debt. For now, the American debt crisis is over. After a last-minute deal between President Barack Obama and his Republican opponents, Congress has agreed to raise the American debt ceiling by more than two trillion dollars, allowing the U.S. to keep borrowing money to fund the country’s operations.
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