Evaluating government contractor probability for success

“Will Government Debt Crush the U.S.?

By Matt Koppenheffer | More Articles 
July 15, 2010 | Comments (14)

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The U.S. government has been naughty. Very, very naughty. In recent years, it has rung up trillions of dollars in debt as it has consistently spent more than it has taken in from taxes and other revenue.

Figures, right? Just as profligate American consumers are getting their comeuppance and learning that hoisting themselves up on an impossibly high mountain of leveragewasn't such a good idea, the government is busy doing the exact same thing.

If you listen to many pundits out there, this rapidly ballooning government debt load is getting ready to cause our entire economy to implode. And it often sounds like there's a pretty compelling argument there. To start paying down that debt, Uncle Sam is going to have to make big spending cuts, raise taxes, or do a bit of both.

Cutting back spending could put a hurting on big government contractors in defense -- such as Boeing (NYSE: BA) and General Dynamics (NYSE: GD) -- as well as more general contractors like Jacobs Engineering (NYSE: JEC) and Accenture (NYSE: ACN). Spending cuts could also put government employees out of work and cut off money to citizens on the dole.

Increasing taxes, meanwhile, has the inevitable consequence of leaving consumers with less money to pump back into the economy. By reducing individuals' income, the government runs the risk of adding more fuel to the housing fire, which would only exacerbate the problems at banks like Citigroup (NYSE: C) and homebuilders like Beazer Homes (NYSE: BZH). Reduced disposable income also means that consumers would have less to spend on a wide range of items -- but especially luxury goods like those at Coach (NYSE: COH).

The future's so bleak
I've seen more than a few pundits, commentators, analysts, and random Joes become frothy at the mouth talking about the economic apocalypse that will be ushered in thanks to the government's debt load. Time will tell whether the roof will cave in on the U.S. economy, but I expect that these folks will end up being far off the mark.

While the government's debt level and budget deficit aren't sustainable, fire and brimstone still isn't a very likely outcome. Of course, it's much easier to get heard on CNBC and other major news outlets if you have an extreme, highly improbable view -- and easier still if you express it while shouting, sweating, wildly gesticulating, or all three at once. If sober, sane views were encouraged, Jim Cramer would have been off the air a long time ago.

But enough of that
Making broad, unsubstantiated claims really isn't all that useful, though. So let's cut the jibber-jabber and take a look at how some of the major debt concerns stand up to the data.

1. The government is weighed down by its huge debt load. For right now at least, this is actually very far from the truth. On average, from 1989 to 2009, the government paid total annual interest equal to roughly 3.8% of total U.S. gross domestic product. In 2009, interest came to 2.7% of GDP. Government debt has ballooned, but currently people are willing to lend to Uncle Sam at very low rates.

2. When interest rates rise, the government is in big trouble. As I highlighted in the point above, low interest rates are helping the government deal with its massive debt load now, so rising rates certainly wouldn't help matters. However, there are a couple of things to consider here.

First off, the government's interest payments may continue to come down even if rates stay put or go up slightly. In the coming months (and years), the Treasury will roll over debt taken out years ago when rates were still higher. In mid-August, for instance, $22 billion of 10-year notes that were paying 5.75% will come due. Currently, 10-year notes are yielding just 3.07%.

Also, most of the marketable government debt is in Treasury notes. As of June 30, the weighted average yield on the Treasury notes outstanding was 2.6%, while the weighted average maturity was 3.6 years out. So it'll be pretty tough for higher rates to sneak up on the government all at once.

3. This level of debt is unprecedented. If you amend that to say "in the post World War II era," then yes, that is correct. Debt as a percentage of GDP was 83.5% at the end of 2009, a level not seen since we were paying off the debt incurred during the Second World War.

I wholeheartedly agree with debt hawks that we should focus on bringing debt down to a reasonable level. What I don't agree with is the idea that that will imperil economic growth. In 1946, debt was 121% of GDP, and 20 years later it was down to 34%. During that two-decade stretch, U.S. GDP expanded 721%, or roughly 11% per year.

Will we repeat that performance? Probably not, but it does suggest that growth can occur while bringing debt under control.

4. We're going to get crushed by taxes. We are going to see higher taxes down the road, but a big part of the reason taxes will increase is that we've been paying less than usual over the past few years. In 2009, total current tax receipts were 17% of GDP. Over the past 20 years, that number has averaged 20%.

5. The economy is being propped up by federal government spending. There's some truth here,  considering the fact that federal government spending as a percentage of total GDP has risen significantly over the past few years -- to 8% in 2009 from 6.9% in 2007. However, 2009's level isn't too far above the 7.2% average of the past 20 years and it's notably below the 9.4% average between 1981 and 1989 (the Ronald Reagan years, if I'm not mistaken).

This is a very polarizing issue, so I hardly expect that this data will convince everyone that the apocalypse isn't coming. Have some thoughts of your own? Head down to the comments section and chime in.

What does Fool Tim Hanson think is the biggest opportunity of the year? I'll give you a hint: It's not in the U.S.”