Friday, August 5, 2011

The debt crisis with numbers we can understand

David Ramsey explains:
If the US Government was a family, they would be making $58,000 a year. They spend $75,000 a year and are $327,000 in credit card debt. They are currently proposing BIG spending cuts to reduce their spending to $72,000 a year. These are the actual proportions of the federal budget and debt, reduced to a level that we can understand.
I don't think even FreeCreditScore.com could save the breadwinner of that family from waiting tables or becoming a troubadour wearing green tights.

I just ran a few additional numbers. If that family reduced its spending by only 4% (to that $72,000) per year, their credit card debt, assuming 4% interest (a realistic long-term rate for Treasuries) would continue to increase to $369,800 in just four years.

If that family were serious enough to reduce spending to pay off their credit-card debt in 20 years, they would have to cut spending by 40%, to $35,100 per year.

No wonder the Chinese are selling off Treasuries and Standard & Poor's is rethinking the U. S. Government credit rating. Obviously, the Congress and the President are not serious about reducing the debt.

Virtual buckeye to Teri Cain Owens on Facebook.

2 comments:

Joel said...

This quote is baloney, see this post.

Harold Thomas said...

Joel:
The post you cite has some good points: The David Ramsey quote should have been better documented, it does ignore earnings, and it doesn't say how the family got to where it is today.

To the last two points, I would say this (and The Paper Trail mostly agrees: Family incomes have been, at best, flat and at worst, downhill since 2008. I'm not sure how raising those points invalidates a simple analogy.

As to saying that some expenditures are more like mortgage debt -- well, maybe. Mortgage debt is used to purchase a physical asset (a home or commercial property) that you plan to hold on to for a period of years, and which serves as security for the loan. Defense spending is mostly for payroll, transportation costs, and consumables like weapons and food. Credit card debt is a better analogy because such debt is mostly unsecured. In any case, debt is debt. It has to be paid off eventually, otherwise the asset will be foreclosed or repossessed and the debtor credit rating will be trashed. In a business setting, the entitlements are more comparable to pension costs (actually payroll, since the Feds borrow from the trust funds).

I ran my calculations (same assumptions: flat salary and 4% interest) on The Paper Trail's figures (salary $58,000, annual spending of $96,000 to be cut by the same 4% to $92,160, and debt of $245,000). Because the family is spending so far above its means, it would be paying $3,840 per year on debt service, while interest alone the first year would be $9,600. In four years, the debt would increase to $274,000.

To pay the debt off in 20 years would require an even more draconian 57% reduction in spending, to $40,850 per year.

So, even if The Paper Trail's figures are completely correct, it does not invalidate my point, which is that Congress is not serious about reducing the debt.

However, I did make one mistake in my post. The reduction in spending using my figures, based on what the family had been spending is actually 51%, not 40%.