THE U.S. NATIONAL DEBT: HOW BAD IS THE PROBLEM?

BACKGROUND & FRAMING OF THE ISSUES

One of the most widely discussed and often misunderstood areas of the U.S. economy is the current amount of the United States’ national debt, which currently totals $15.2T. Yes, currently the U.S. Government owes a collective $15.2T to both American & foreign households & institutions. This borrowing was necessary since the U.S. government has spent in excess of its tax revenue over the years, which, in economic speak, is called “deficit spending”. In short, the U.S. government must borrow when its spending exceeds its tax revenue. Over the past 10 years especially, government spending has well exceeded tax revenue almost tripling during that period. A combination of two wars, two recessions, and two political parties that have not yet made deficit fighting an urgent priority accounts for this surge in debt over the past 10 years.

The shear magnitude of the U.S. national debt ($15.2T), coupled with alarmist comments by the U.S. Congress and the American press lead most Americans to conclude that our country is in a very precarious position and is perhaps on the verge of bankruptcy. Moreover, many Americans are aware that future Federal payouts for social security and Medicare alone, assuming no benefit changes, will rise at a much faster rate than the current tax revenues for those same social programs further increasing the national debt.

THE IMPORTANCE OF DEBT TO A COUNTRY

Contrary to what many Americans believe to be conventional wisdom, debt is actually a beneficial and recommended pursuit, if used correctly, since it enables a nation or an individual to equalize income and expenditures over time, and improve standards of living earlier than what would otherwise be attainable. It is easier to accept this premise on the personal front as millions of Americans have been able to improve their standard of living currently by pulling their future incomes forward via borrowing to purchase homes, cars, and education. Of course, we all know that debt, like a car, can cause damage if it is not used and managed wisely, and that is where many alarmists focus and even some go so far as saying that all debt is bad and should be avoided. Many nations, with Russia being a prime example, have been criticized by economists for not utilizing enough national debt to improve their economy and their citizens' standards of living. Thus, hopefully, with a conclusion that debt is actually a "good thing", if used for productive purposes, one can then proceed to the next section as to what are acceptable levels of national debt.

$15.2T: AN AFFORDABLE LEVEL OF NATIONAL DEBT?

The United States' current level of national debt, has grown, according to most economists, too rapidly over the last decade and has developed into what many economists believe to be the top fiscal problem in the United States. The problem is that with the continued rate of growth in the debt experienced over the last 10 years a "debt crisis' could develop meaning that lenders to the U.S. Government will become leary of lending because of the fear of not getting their loan money paid back. In addition, a greater loss of confidence in the U.S.'s ability to pay back their loans will cause the Government to have to raise interest rates to entice new lenders to take a chance and lend their money to the Government. This raising of interest rates will permeate through the economy and increase the cost to U.S. households and firms to borrow and purchase homes, and capital. 

National accounting statistics show clearly that the U.S.'s 104% national debt/GDP percentage is, in fact, well above average compared with most other modern economies, but it is certainly not the highest as economies like Japan and Italy currently have debt/GDP levels at 204% and 130%, respectively. Moreover, the level of U.S. national debt as a percentage of GDP (104%) is relatively close to where it was back in 1950 after having financed World War II. Our nation’s highest level of debt relative to GDP was 121% back in 1945. The key point is that debt must be benchmarked to our nation’s income which is GDP. 

WHO IS THE NATIONAL DEBT OWED TO?

Much has also been made of the fact that $4.6T of the U.S. national debt, or 30%, is owed to foreigners. The fact that a good chunk of the debt is owed to foreigners is not nearly as much of a concern as the growth of the national debt in general. Foreign debt is nothing more than foreigners temporarily saving their U.S. dollars, the same dollars sent to them for their products imported into our country. Some foreigners elect to temporarily save these dollars and earn interest by lending them back to the U.S. Government by purchasing bonds. I don’t consider the fact that debt is “foreign” to be a problem, as these dollars will eventually be paid back to the foreigners with interest and these same dollars will, in turn, be spent back into our U.S. economy. Debt held by foreigners is “dollar savings” just like debt held by American citizens is “dollar savings”, so, in other words, it is really not that important whether the debt is held by foreigners or US citizens since eventually those dollars will be spent back into the U.S. economy since they can’t be spent in another economy!

WHAT ABOUT THE FUTURE?

Many have argued that the U.S. aging population (the "baby boomers") moving into their retirement years will cause social security and Medicare alone to "shoot through the roof" and cause the U.S. national debt to reach unacceptable and unmanageable levels, potentially, some say, even bankrupting the U.S. Government. Many use extrapolations of future social security and Medicare payments out into varying distant futures based on the number of retiring baby boomers and increasing life spans concluding that there are trillions of unfunded government obligations ($51T is one recent estimate) which are insurmountable. The problem with most all of these analyses is that they fail to address how simple and relatively small adjustments make these problems disappear. For example, on social security, an increase in the social security tax rate from its current rate of 12.4% (6.2% for employees matched by employer) to 15.9% is deemed by one source to fully fund social security at today's benefit structure out into perpetuity (i.e., forever). Similar analyses are out there for other actions such as updating social security retirement ages to be more consistent with longer life spans. What will likely happen, once Congress actually addresses the fiscal imbalance, will be a combination of different types of changes including reduced benefits, higher taxes, later retirement ages, and reallocations of the overall federal budget. 

What is perhaps our nation's top concern regarding the growing national debt is that our Government officials have shown little political will to halt the rapid growth in the national debt. For fiscal year 2011, our annual deficit was $1.3T, or 9% of GDP, adding a corresponding amount to the growth in the national debt. Most economists would say that the nominal rise in the national debt should be no more than $0.4T, or 3% of GDP, as it is actually acceptable for the debt to rise at no greater a rate than the growth in annual GDP. Recently, the Joint Select Committee on Deficit Reduction, a group of 6 Democrats and 6 Republicans, failed to agree on any ways to achieve $1.2T in cost savings OVER 10 YEARS evidencing that our nation's political posturing is more important than the welfare of our nation (at least for now). Hopefully, this political posturing will change after the November 2012 elections.

And one final point of optimism; the national debt never has to be paid back! Many non-economists believe that the national debt must be paid back by the current or next generation through higher taxes. It does not! The U.S. Government is in a unique situation in that it can simply refinance the debt (issue new debt to pay for maturing debt) into perpetuity. The key point is that the debt must be first reduced an acceptable level of GDP (90% of GDP would be a good target, in my opinion) and then the national debt must be maintained at that 90% of GDP or less out into perpetuity. This means that the national debt can grow nominally each year as long as it does not grow any faster than the rate of growth of our economy (GDP) and tax revenues, which have been historically around 3% per year. Just like families growing in wealth continue to increase their nominal amount of debt held, Governments can do the same without any risk to their credit rating!

CONCLUSION

Today's $15.2T U.S. national debt is rising at too fast a rate. In just 10 years, the U.S. debt level has gone from 58% of GDP in 2000 to 104% today.

The U.S. economy has some sizable challenges ahead in terms of keeping our increasing national debt in line with increases in our economic growth (GDP). Most notably, our demographic trends of fewer births and increased retirees with longer life spans will put additional strains on our country's debt/income relationship.

Should we be optimistic?  Our Government has shown before that we can pare our debt down. Our nation restored fiscal soundness after World War II when national debt reached an all time high of 121% of GDP and again in the 1990’s as our Government made significant changes in government spending and taxation policies to curb our debt from 67% of GDP to 58% of GDP.

On the other hand, 2011 was a miserable display of Congressional effectiveness, in my opinion, as Democrats and Republicans could not work effectively together to try and stop the high deficits and debt explosion. My view is that it may take either a debt crisis or new leadership in Washington to actually cause the welfare of the nation to trump political power and positioning.

The next 5 years will be very important years in our country to establish the fiscal discipline to restore our debt to very manageable levels. If not…well….move over Greece, here we come!

Questions:

1. How would an economist determine whether the nominal size of the national debt is too high?

2. What are your reactions to Japan's and Italy's debt being higher than the United States' debt. Does this give you some hope that our country still has several more years to fix our deficit/debt problem?

3. $1T of our $15.2T in national debt is owed to China. What would happen if we paid off that debt.? What would happen if China decided not to lend to the US anymore?

4. Explain why the United States never needs to nor will pay the national debt back and why their really isn't a $15.2T burden to be paid back by either my generation, yours, or your children's? Does this fact make you feel at least a little less concerned about the high level of the debt?

5. If you were President, what areas of government spending cuts and/or tax increases would you propose?

6. How would you balance trying to stimulate the economy (fiscal policy, lower taxes, increased goverment spending raising the debt) as our economy's rate of GDP growth is very slow (2%) and our unemployment rate is high (8.5%), relative to the need to curb the growth in our deficits (higher taxes and less government spending) which could hurt the recovery?