If you had a choice, would you let the U.S. government manage your money? OK, so that's a rhetorical question. But humor me. I know I wouldn't let it. The government's failure isn't limited to the Bush administration or the Republicans who now control Congress. For administration after administration, no matter which party held the White House and Congress, the federal government has consistently violated the standards of sound financial management. Given a choice, none of us would ever let anyone with the U.S. government's record of financial management touch our money. And any household that managed its money so foolishly would be headed for bankruptcy. Unfortunately, most of us don't have a choice about letting the government touch our money. The government's hand reaches deep into all of our personal finances. But if we fight hard enough, we do have some say about how that money is managed in the future.
Budget and Economic Outlook on Tuesday. And as we wait for President Bush to deliver his own budget, now is a good time to step back from arguing about the details of any specific budget plan and look at the terrible job that our government does at managing our money as well as the consequences of that mismanagement. Let's start by looking at how the government does on my five rules for managing debt. Why start with a look at how the government manages its debt? Because it's a useful indicator of how the government manages all of our money. With the annual budget deficit running at $400 billion to $500 billion for the next few years before accelerating as more baby boomers retire, we're likely to add the huge sum of $5 trillion to the total federal debt over the next 10 years.
The cost of servicing that debt, already 7% of the annual U.S. budget, is likely to climb, costing each household in the U.S. an extra $3,000 in interest payments each year by the end of the that 10 years, according to the Brookings Institution. And total U.S. debt is increasingly the 800-lb. gorilla that drives interest rates and the value of the U.S. dollar. It also influences decisions on how much the U.S. government can spend on "discretionary" fripperies such as education, environmental protection, food and drug safety, securities regulation and homeland security. Overall, the government earns an 'F' on debt management. But the score is even worse when you look at how the U.S. government does on each of my five rules of smart debt management. In some areas, the government isn't merely failing to do a good job; it's actively and aggressively headed in exactly the wrong direction.
Of course not. Most of the revenue collected from current taxes is used to pay current benefits. The surplus, and right now there is a surplus, goes into a trust fund for Social Security or Medicare, where it is invested in "special issue," bonds created for the trust funds and only available to the trust funds. According to the Social Security Administration, the interest rate on a special issue is the average of the interest rates on all U.S. Treasury notes and bonds of more than four-year maturities. Can you see the three problems with this? First, because the interest rate on a special issue is an average, it is always lower than the yield on the longest U.S. Treasury bond. So in 2002, when the 30-year Treasury bond was paying 5.43%, the Social Security trust fund was buying special issues with an average yield of 4.87%. Second, because these special issues can't be sold on the public bond market, the trust funds can't reap any capital gains on the bonds if interest rates fall. Special issues can only be redeemed by the U.S. Treasury at face value. So the trust funds missed, for example, the spectacular appreciation that other bond investors reaped as interest rates on 20-year Treasury bonds fell to 5.43% in 2002 from 13.01% in 1982. And third, because the U.S. government has discontinued the 20-year and 30-year Treasury bond series, the trust funds are buying special issues with lower yields and implied shorter maturities even as the life span and thus the duration of the obligation owed to U.S. retirees increases.
Rule 4: Does the government actively strive to drive down the cost of borrowing so that we'll pay less interest on existing and future debt? Not so you'd notice it. In fact, I believe that current government budget policies will drive up interest rates on the publicly held debt in the next decade. (This follows on the decision of the previous administration to do away with the 30-year bond so the government couldn't lock in the low bond yields of the late 1990s for the long run.) Running the printing press to fund annual deficits has its cost: The government (which in this case means those of us who pay taxes) has to pay investors (in this case overseas investors, because Americans don't save enough) to buy and hold dollars (in the form of Treasury bills, notes and bonds). At some point, especially now that the dollar's fall has put investors on notice that the dollar might decline in value in the future, we'll have to pay overseas investors more to hold dollars. Paying more means higher interest rates on U.S. debt instruments. Not yet; foreigners stepped up to the window in a big way to buy dollars in December. But it is inevitable that as long as we run huge annual deficits, we will get higher interest rates. The debt management policies of the U.S. government will add more debt and at higher interest rates to our balance sheet.