If our economy was resilient we would not be so concerned about budget forecasts. If we had a rainy day fund -- some cushion to fall back on -- those tiny changes in our future projections in the Consumer Price Index, the yield on the 10 year treasury note, the unemployment rate, etc... would not matter nearly as much. But we have a long-term budget that leaves us very little wiggle room and unfathomable obligations far into the future. We need the economy to perform, to exceed our past performance, or we are in deep trouble.
As anyone who is familiar with compounding interest will tell you, take any number and compound it out for a couple of decades and, even at low rates, it becomes a much bigger number. And our national debt figure is not just "any number" - it is one of the biggest numbers you'll ever see (until next year): $14 trillion. That is:
That's a big number.
Let's say that we pay 2% interest on that debt and we project that assumption out for 20 years. Without adding any more to the debt (an annual deficit of $0, which is not going to happen any time soon), our $14 trillion would grow to $20.8 trillion.
But, if we messed up on our interest rate projection by just one percent and wound up paying 3% over those 20 years, we would find ourselves owing $25.3 trillion, a full 22% more.
Such an error is not inconceivable. It's not even unlikely. There are so many things that impact interest rates, including the degree of risk an investor perceives with a currency. How valuable will dollars be in the coming years? Will the Federal Reserve create inflation and reduce that value? Will the United States lose reserve currency status and see the dollar devalue in terms of gold, oil and other currencies? When a savvy investor buys dollars or dollar-denominated securities, they are considering these questions and more regarding the status of the currency.
And if the currency is found lacking, if investors are not confident that the dollar will hold its value, then they will demand a higher interest rate when they loan us money. (By "demand" I simply mean that they will invest their money elsewhere unless we raise our rates high enough to make it attractive in comparison to other investment.) Since a higher rate makes the likelihood of repayment more shaky, you can see how this is a fine line to walk. Cross over the "risky" line and people start pulling their money out. Then things go bad in a hurry.
As an example, see Greece in April of last year. This is what happened to the interest rate on their 2-year notes (loans that will be repaid in two years).
In a month Greece went from paying under 5% to over 13% because investors were worried they would not get all their money back. And Greece was essentially unable to borrow for 10 year, 20 year or 30 year intervals the way much of our debt (decreasingly) is financed.
Let's go back to our $14 trillion and pretend that, instead of 2%, we wind up paying 5%. That is still nowhere near Greece, so we're not talking about collapse of the currency or anything like that. In 20 years at 5% our $14 trillion turns into $37 trillion. We would be off our 20-year projection by 80%.
So why is this important?
Our cities are reliant on transfer payments from the state and federal governments for the basic maintenance of their infrastructure systems. There is hardly a major infrastructure project that is constructed or maintained at the local level that does not contain significant infusions of state and/or federal money. If this money goes away (we actually believe it is "when" and not "if"), cities are going to find themselves incomprehensibly overextended.
Think things are tight now? Coming off of a couple of decades of growth, with most of our municipal debt financed at low rates, with comparatively little being paid out thus far on municipal pensions, with our infrastructure relatively young in its life cycle, this is not tight. This is the high water mark. Things are not going to get easier.
We're all reliant on the federal government now, and so the projections that they use to make decisions today become really critical. Are we taking a conservative approach, leaving cushion in for unforeseen circumstances? Or are we using unrealistic numbers, pinning our future to a shoot-the-moon strategy where everything must go perfectly for it all to work out?
The Congressional Budget Office's report titled The Budget and Economic Outlook: Fiscal Years 2010 to 2020 provides some answers. Here's what they say about growth rates (our emphasis added):
Discrepancies between those projections and actual economic conditions can make budgetary outcomes differ significantly from the baseline. For instance, CBO’s economic forecast anticipates that real GDP will grow by 2.2 percent in calendar year 2010, by 1.9 percent in 2011, by an average of 4.4 percent a year from 2012 to 2014, and by 2.4 percent annually from 2015 to 2020. If the actual growth rate of real GDP was 0.1 percentage point higher or lower each year, the cumulative deficit projected for the 2011–2020 period would be higher or lower by about $300 billion. Discrepancies between those projections and actual economic conditions can make budgetary outcomesdiffer significantly from the baseline.
The 4.4% annual rate for next year and the two following should be compared to a 3.3% average since the transition after World War II.
Here is their projection of government spending, which is supposed to fall dramatically starting next year. For discretionary spending (like infrastructure), the projections simply continue downward indefinitely. In other words, past performance bears no resemblance to future projections.
The CBO has an equally rosy take on unemployment, which it projects will decline significantly and return to 2005 levels in the next three years. Remember 2005? Liar loans and credit default swaps? It wasn't real...so how do we get there for real this time? In three years nonetheless...
Consider this statement in the CBO report and see if it makes you feel confident:
Severe economic downturns often sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, the disparity between the desired and actual stocks of capital assets and consumer durable goods widens quickly, and spending by consumers and businesses can accelerate rapidly.
So to paraphrase the CBO, it's just gotta get better, right?
We've tethered the future of our cities to a stream of revenue from the federal and state governments that is premised on the economic future being an improved version of the past. Since the past was a unsustainable, fairyland, Ponzi-scheme manifesting in multiple financial bubbles, which since have exploded leaving the present filled with excess debt, zombie banks, underwater mortgages and record unemployment, are we realistic in our expectations of the future?
Here's the salient point: If we lived in a country of Strong Towns, it would matter to us much less.
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