If we include debt the government guarantees from Fannie Mae and Freddie Mac, and long-term Social Security and Medicare liabilities, outstanding federal debt is now well in excess of 100% of the size of the entire U.S. economy. That's a worrisome statistic since studies have shown that that such a level of government spending is beyond the tipping point that pushes countries in debt default, hyperinflation, currency depreciation, and markedly lower economic growth. This is the fate that awaits the U.S. economy unless radical action is not taken quickly. For the U.S. economy to grow strongly and its citizens to achieve more financial security, I believe that we must not only reduce the rate of debt accumulation, but begin to reduce the size of our outstanding debt. Otherwise we risk the chance of debt growth overwhelming any growth our economy can muster.
But at least the recent spending reductions are a step in the right direction to achieve that, right? Well, during the time Congress debated these spending decreases, the interest accumulated on outstanding federal debt grew larger than the proposed spending reduction. Since the interest on outstanding U.S. federal debt amounts to about $400 billion a year, or more than a billion a day, any efforts to address the ballooning debt situation will need to do two things.
First, the yearly budget will have to be balanced so as to not add to the outstanding debt. Secondly, the debt will continue growing unless there is a government surplus each year. That's because of the interest the government must pay on the debt that is already outstanding. As mentioned above, outstanding publicly held debt - debt the government owes to investors and foreign governments - amounts to about $10 trillion. If we assume an average 4% interest rate on that debt, that amounts to an extra $400 billion of debt that will be added to the debt pile. If interest rates were higher, say 8%, that would mean about $800 billion a year would be added to the federal debt, just from interest on the debt that already exists.
Assuming that the government is able to get away with currently low interest rates for some time to come, this still amounts to perhaps an extra $400 billion that needs to be cut from yearly federal spending to reverse the size of the federal debt. Since current federal government revenue is in the neighborhood of $2.3 trillion, yearly federal spending would have to fall from today's planned $3.7 trillion or so to under $2 trillion. So instead of cutting federal spending by roughly 1%, as Congress recently agreed to, it would mean cutting nearly 50% from federal spending.
To make such cuts will be mighty difficult, particularly since Medicaid and Medicare, Social Security and Defense spending alone amount to more than $2.2 trillion of yearly spending by themselves, to say nothing of the federal departments and discretionary spending.
And those mandatory programs like Social Security and Medicare will only see higher spending in the years ahead as boomers retire and age. We thus have a perfect example of the dangers of politicians worrying more about short-term reelection campaigns than doing what's best for Americans in the long-term. The current financial situation the U.S. government finds itself in has been warned about for decades, and little has been done to check the growth in spending.
We are now in a desperate situation with our country's finance, but one that Congress and our presidents have been unwilling to address. That's unfortunate, and recently it has allowed and encouraged the Federal Reserve to step in and allow our government to continue its overspending ways, which is only delaying and worsening our day of reckoning. And that's what I'll talk about next time.