This is a continuation of the comment on federal debt [Part I,
question 1-3] published on Jan 10, 2011.
*4. Will Congress entertain not raising the statutory debt limit?*
Congress will increase the statutory debt limit prior to the deadline.
There is not even an inkling of doubt about this eventuality. But,
unfavorable posturing by politicians, prior to taking the appropriate
action, is nearly certain and tentative market concern will prevail.
The terms of the deal the Republicans will strike to raise the debt
limit is the source of uncertainty not whether they will raise the
borrowing limit. The Treasury Department estimates that the national
debt will hit the statutory limit between March 31 and May 16. In the
meanwhile, Treasury Secretary Geithner has indicated that the Treasury
could take "exceptional actions" to delay the deadline by suspending
the sale of state and local government securities, which would buy
time for a few weeks.
*5. What are the implications of the growth in federal debt?*
First, interest costs have to be considered. Net interest outlays in
2010 amounted to $197 billion or 1.4% of GDP (see Chart 1). The
Congressional Budget Office's estimates focus only on the publicly
held debt. Most of the difference between total federal debt and that
held by the public is accounted for securities held in the Social
Security Trust Fund. The low interest rate environment helped to
contain interest costs despite a large increase in federal debt. Going
forward, interest costs as a share of GDP are expected to double
reflecting growing debt and higher interest rates.
Second, the United States has a small window to repair the strategy to
tackle the imbalance. For now, financial markets have not questioned
the status of U.S. federal debt and they continue to view these
securities as a "safe haven" in situations of market upheaval. Future
interest rates and deficits are uncertain and will be determined by
the economic growth trajectory and future legislative actions. Recent
projections of the federal deficits and debt (see Charts 2 and 3 in
Part I, comment of January 10, 2011) suggest that the current market
assessment of the U.S. debt situation will be subject to
reconsideration if there is no effort to contain the growth of federal
debt. The United States has a small window between now and when the
economic and market environment return to normal conditions to address
the severe fiscal imbalance. Third, each percentage point in the U.S.
debt-to-GDP ratio translates into higher interest costs, with
additional economic costs such as "crowding out" of private
investment. This in turn lowers the size of the economic pie and
erodes the standard of living of future generations. In the
near-to-medium term, financial markets will focus on the policy
changes implemented to address reduction of federal debt.
*6. What are the reasons for growth of federal debt? *
A major part of the increase in the federal deficit, following the
financial crisis and the Great Recession, reflects a severe loss of
tax revenue, a jump in outlays, partly from an increase in
expenditures from automatic stabilizers and partly due to legislative
action to stabilize financial institutions and the economy. These
deficits translated into a sharp increase in publicly held debt from
36% at the end of 2007 to 62% by 2010. It is important to note that
the projected increase in federal debt during the decade ahead is due
to entirely different reasons. Medicare, Social Security, and interest
costs are the three major factors accounting for the growth of public
debt. Therefore, these costs need to be addressed after self-sustained
economic growth becomes evident. Contrary to common understanding,
discretionary outlays are predicted to show only a small increase in
the next decade.
*Small Business Optimism Index Declines, Poor Sales Persists as the
Foremost Problem*
The Small Business Optimism Index edged down to 92.6 in December from
93.2 in the prior month (see Chart 3). More importantly, a
significantly large percentage of respondents (33%) continue to
indicate that poor sales are the foremost problem (see Chart 4) in
December compared with tally in the September-November (30%) period.
Source: Fxstreet.com
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