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Flashback: What If the U.S. Government Paid Off Its Debt?

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The current projections for U.S. government debt are grim. According to the Congressional Budget Office, national debt held by the public will hit $18 trillion in 2021, up from about $10 trillion today. As a percentage of GDP, public debt is forecast to go from 69% today to 84% by 2035.

Most Americans are all too aware of these numbers. In an NBC/Wall Street Journal poll earlier this year, eight in 10 said they were worried about the national debt. In July, a Gallup survey showed 42% of Americans were against raising the debt ceiling.

But it's easy to forget how different the outlook was just 10 years ago. Back then, the government was running record surpluses, and was forecast to repay all public debt by 2012. In his 2001 State of the Union speech, President George W. Bush minced no words: "I hope you will join me to pay down $2 trillion in debt during the next 10 years," he said. "At the end of those 10 years, we will have paid down all the debt that is available to retire."

That never happened, of course. But interestingly, the prospect created almost as much angst as today's record deficits.

Planet Money, part of NPR, recently obtained "a secret government report" through the Freedom of Information Act. The report, titled "Life After Debt" (you can see it here) is dated November 2000, and goes through a list of problems the government anticipated it would face once it repaid all of its debts.

The Federal Reserve in particular worried how it would conduct monetary policy. The Fed normally buys and sells Treasury securities to influence interest rates. What would it do once there were no more Treasuries to buy?

One idea was that rather than using Treasuries, the Fed could buy and sell private assets like CDOs. The report writes:

The Fed, if granted authorization could use private securities to conduct monetary policy.

Private institutions could provide a relatively sanitary solution to the Fed' s problem of replacing Treasury securities in the conduct of monetary policy by creating new, very low-risk securities constructed from a pool of private debt securities. Such securities would be packaged in a way similar to mortgage-based securities currently issued by ... Freddie Mac and Fannie Mae...

If you're familiar with the genesis of the housing bubble, this should make you shudder. The housing market took a fatal turn when Wall Street began packaging "very low-risk securities" into collateralized-debt obligations, rating them triple-A, and selling them to global investors who had an insatiable appetite for the products. How much worse would the bubble have been if the Fed were a major buyer of private CDOs early in the decade? It's almost incomprehensible to think.

The Fed didn't have to stop at CDOs, of course. As the report notes, "In principle, the Fed can conduct open market operations on any number of assets including corporate bonds, agency debt, sovereign debt, and even equities." More bubbles to be blown -- particularly in stocks, since the report was issued in 2000, during the dot-com bubble.

And then there's the federal government itself. Ten years ago, the government was on track to run budget surpluses as far as the eye could see. If those surpluses couldn't be used to pay off debt, where would the money go?

One idea was for the government to start buying up private assets. The report calls this "accumulating a federal asset." "Other governments have pursued a strategy of investing in equities and other financial market offerings, domestically and internationally," it writes.

The obvious problem with this idea: Whose stock do you buy? If you thought the Solyndra scandal was bad, just wait. "Of course significant and legitimate concern revolves around governments' ability to passively invest sizable sums in private ventures," the report notes. In 2001, then-Federal Reserve Chairman Alan Greenspan argued against buying up private assets for the same reason. "It would be exceptionally difficult to insulate the government's investment decisions from political pressures," he said.

Ironically, the government did end up buying hundreds of billions of dollars' worth of private assets, but for a very different reason: The 2008 bailouts left taxpayers with huge stakes in General Motors (NYSE: GM  ) , Bank of America (NYSE: BAC  ) , Citigroup (NYSE: C  ) , JPMorgan Chase (NYSE: JPM  ) , and hundreds of other companies.

There's one big lesson to take away from all of this: If we were so spectacularly unable to foresee the future of our public finances 10 years ago, why do pretend like we can see it today? Today's estimates of future deficits mentioned at the beginning of this article are based on the same methodology as the ones used 10 years ago. Yet while we laugh at the dismal track record of pasts forecasts, we tend to take current ones very seriously.

That makes me wonder: What widely accepted forecasts are people making today that be will comically wrong 10 years from now? There's no way of knowing -- only that it's bound to happen.

Fool contributor Morgan Housel owns B of A preferred. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of JPMorgan Chase, Citigroup, and Bank of America. Motley Fool newsletter services have recommended buying shares of General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (20)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 28, 2011, at 4:22 PM, dbtheonly wrote:

    One prediction for you: Health care/health Insurance will still be a hopeless muddle.

  • Report this Comment On October 28, 2011, at 6:53 PM, mhteg wrote:

    If you US didn't spend all their money on the war, they wouldn't have to raise the debt ceiling. They either have to raise the debt ceiling or cut spending costs or China might take over. If you don't know what the US debt ceiling is, this article gives an awesome explanation on it.

  • Report this Comment On October 28, 2011, at 6:58 PM, cmfhousel wrote:

    ^ The debt ceiling is self-imposed. It's nothing like a credit card limit.

  • Report this Comment On October 28, 2011, at 7:48 PM, Hawmps wrote:

    In the context of the article and having all US debt paid off in 2012 - It seems simple to me really (not to be confused with easy)... the question of "gee, what are we to do with ourselves when we have no US debt to manage?" is ludicrous. Why does the Fed have to buy US debt? How about purchasing non-US sovereign assets and the dividends (interest) can actually (gasp!!!) make money for We The People which could be uses to build roads and other infrastructure from dividend and interest profits instead of issuing bonds going into more debt to do what needs to be done. Oh that's right... that requires a huge assumption that the government would know how to make any kind of profit much less know what to do with it. How silly of me. The true meaning of the term "lost decade" is the blown opportunity to be a debt free society. Let's be perfectly clear that it was not the war that ballooned our debt (although it helped), but it made a great excuse for other monetary policy and tax policy decisions of the past ten years.

  • Report this Comment On October 28, 2011, at 8:41 PM, ynotc wrote:

    " The Federal Reserve in particular worried how it would conduct monetary policy" If the Feds manipulation of our financial system really worked then we would not have these bubbles and recessions. Unfortunately most people think that the answer is more of the same. In this regard, nothing succeeds like failure.

  • Report this Comment On October 28, 2011, at 10:59 PM, GETRICHSLOW2 wrote:

    Here's an idea. Let's shut the Fed down because it is no longer needed.

    If we must keep it around, I have some imaginary triple-A assets I will sell them.

  • Report this Comment On October 28, 2011, at 11:04 PM, whereaminow wrote:

    LOL, or the Federal Reserve could just be abolished. I love how it's a "problem" that the Federal Reserve would no longer be able to perform its Soviet-like function of centrally planning interests. As if that's a bad thing...


  • Report this Comment On October 28, 2011, at 11:38 PM, VolkOseba wrote:

    "If we were so spectacularly unable to foresee the future of our public finances ten years ago"

    What you mean "we?" Not everyone was blindsided by the negative consequences of cheap money. Of course, according to you that was just some coincidence, they couldn't have possibly known better than the Keynesians... lol.

  • Report this Comment On October 29, 2011, at 12:26 PM, NovaB wrote:

    The biggest holder of US "public" debt is the United States federal government.

    At the very best this article is intentionally misleading.

    Four Pinnochios for Morgan Housel and Motley Fool,

  • Report this Comment On October 29, 2011, at 1:08 PM, cmfhousel wrote:

    ^ What part of the article argues otherwise? This article has nothing to do with the structure of debt ownership. And in fact, the debt/gdp figures used in the first paragraph are for debt held by the public, which excludes government-held debt.

    From an article I wrote a few days ago:

    "The largest holder of U.S. debt is the federal government itself. Various government trust funds like the Social Security trust fund own about $4.4 trillion worth of Treasury securities. The Federal Reserve owns another $1.6 trillion. Both are unique owners: Interest paid on debt held by federal trust funds is used to cover a portion of federal spending, and the vast majority of interest earned by the Federal Reserve is remitted back to the U.S. Treasury."

    No Pinnochios needed.

  • Report this Comment On October 30, 2011, at 1:29 AM, CaptainWidget wrote:

    Tragically correct. What will happen if the Federal government pays down it's debt?

    Answer: It will still continue to grow.

    We need a finite cap on the size of the federal government, not a subjective plan to pay back an arbitrary amount of money at an arbitrary time.

  • Report this Comment On October 30, 2011, at 10:37 PM, wolves83 wrote:

    If there are surpluses and no debt than lower taxes! Why try to maintain a revenue if all of it is not needed? Unfortunately, politicians are like most Americans and believe they "need" much more than they actually do thus the money will be mismanaged and wasted.

  • Report this Comment On October 30, 2011, at 10:44 PM, cmfhousel wrote:

    ^ Because eventually you'll have a war (maybe two), an expensive Medicare expansion, and a recession (maybe two, with one being the biggest since the Great Depression). All need to be paid for.

  • Report this Comment On October 31, 2011, at 11:02 AM, BMFPitt wrote:

    "Ten years ago, the government was on track to run budget surpluses as far as the eye could see. If those surpluses couldn't be used to pay off debt, where would the money go?"

    There are people out there who are bewildered by the question of what to do if the government is collecting more in taxes than is required to run the government?

    "Because eventually you'll have a war (maybe two), an expensive Medicare expansion, and a recession (maybe two, with one being the biggest since the Great Depression). All need to be paid for."

    Outside of a moderately sized rainy day fun held in "cash", all of those things could be paid for when the need arises, with either increased taxes or debt, depending on the nature and duration for which the additional funds would be needed.

  • Report this Comment On October 31, 2011, at 9:39 PM, duelles wrote:

    Perhaps the closest we can get to telling how money will flow around our econmoy would be demogrpahics. People retiring, creating new households, and potential job prospects are pretty good short term indictors. Each, of course, gets tweaked by new late retirees, putting off babies and new household creation due to the economy.

    But demos are a pretty good indicator of where America will be spending money. Demos are very neglected in forecasts by analysts - not the best companies, though.

  • Report this Comment On October 31, 2011, at 9:43 PM, Hawmps wrote:

    It's a double edged sword...

    On one side you don't want to run up massive debt and have to raise taxes or cut "social servics" to pay for it.

    On th eother hand, you don't want to establish trust funds for surplusses for things like infrastructure build-out / replacement, or social security because then you greedy politicians drooling over it. Oh yeah, they already raped the social security trust fund... nothin but a $4.4T box of IOUs... case in point.

    Good article... 2 thumbs^

  • Report this Comment On October 31, 2011, at 10:14 PM, Hawmps wrote:

    to tag onto duelles good comments...

    Developers and bankers don't seem to look at demographics much either. If they did, they would have seen supply was drastically outpacing demand in most areas of the country and we wouldn't have so many vacant subdivisions and we wouldn't have newly graded subdivisions being plowed under back into farm land. In many, many cases you can look at data available before ground breaking of a development and you can ask, "what made you think this was a good idea to build here, now, in the first place?" When you have for an example, say, 400 - 500 building permits being pulled per year for new homes during the "boom" in a given area, and there are 700 - 800 new lots per year coming online during the same period, then you still have to compete with already existing inventory.... there's your sign.

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