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Economic Forecasts

The Real Debt Crisis

The nation's debt will grow rapidly over the next two decades as entitlement spending surges to meet the demands of more than 80 million retiring baby-boomers.

The numbers look ominous. To make way for a flood of new debt that the Treasury will sell, Congress recently passed a measure to increase the ceiling on our national debt to more than 10.6 trillion dollars. Moreover, the White House projects that the amount by which the federal government's total annual expenditures exceed its revenues will reach a record $482 billion for the fiscal year that ends September 2009.

On top of that, Congress has approved government guarantees for mortgage debt issued by Fannie Mae and Freddie Mac. That could add more than $5 trillion to the government's ledgers. Some are asking whether the Treasury can retain its triple-A rating in the face of this mountainous debt.

It's all relative. Despite these gloomy developments, the debt news is not threatening, at least in the short run. First, the burden of any debt must be measured against income. For someone earning $20,000 a year, a $50,000 debt might be crushing; but to a millionaire, it is manageable. Although our national debt is large, the annual output of the U.S. economy -- our gross domestic product -- now exceeds $14 trillion. With a national debt now totaling $9 trillion, the ratio of debt to GDP is only 63%.

Compared with historical figures and the ratios of other countries, this is acceptable. After World War II, the debt-to-GDP ratio in the U.S. was more than 100%. It is now lower than the average of the four largest European economies and less than one-half the level in Japan. In fact, both our debt-to-GDP and annual deficit-to-GDP ratios are close to the stringent levels required to become a member of the European Monetary Union (levels that many current EMU members fall short of today).

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Although our total government debt is large, about one-half is actually owned by U.S. government agencies, so our net debt -- the amount financed by investors -- is about $5 trillion. The single largest investor in U.S. government bonds is the Social Security Trust Fund, with $2 trillion, followed by pension funds for government workers, the Federal Reserve and a slew of other governmental agencies. Nearly one-half of the remaining $5-trillion debt is held by foreign investors.

It is virtually impossible for the Treasury to lose its triple-A rating because the Federal Reserve stands behind the Treasury 100%. Do you think the Fed, created by Congress, would deny its own government the funds it needs to finance the debt while it bails out private firms, such as Bear Stearns? The Fed can credibly stand behind all government debt because Treasury bonds are promises to pay Federal Reserve Notes -- U.S. currency -- and the quantity of those notes is under the Federal Reserve System's control.

The big issue. The government's most pressing problem is not the current size of the national debt. Rather, the most urgent problem for policymakers is how to deal with an aging population. The nation's debt will grow rapidly over the next two decades as entitlement spending surges to meet the demands of more than 80 million retiring baby-boomers. Jagadeesh Gokhale and Kent Smetters, commissioned by the Treasury in 2002 to estimate the liabilities of the Social Security and Medicare trust funds, came up with a mind-boggling $73.9 trillion, and many economists believe that number is too conservative.

The trustees of the Social Security Trust Fund estimate that in less than ten years, payroll tax revenues will fall below promised benefits. By 2041, they say, the entire fund, which at its peak will have grown to nearly $6.7 trillion, will be exhausted. And the numbers are even worse for Medicare's Hospital Insurance Trust Fund.

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That is the really scary part of our national debt. Keep your eyes peeled for proposals to reform entitlements and not on the short-term numbers that capture the headlines.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania's Wharton School and author of Stocks for the Long Run and The Future for Investors.