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

BACKGROUND and 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 $18.8T. Yes, currently the U.S. Government owes a collective $18.8T to both American households and institutions ($12.6T or 67%) and to foregin households and institutions ($6.2T or 33%). This borrowing occurred because 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 15 years especially, government spending has well exceeded tax revenue almost tripling the national debt 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 1 5years.

The shear magnitude of the U.S. national debt ($18.8T), coupled with alarmist comments by the U.S. Congress and the American press lead most Americans to conclude that our country is perhaps on the verge of bankruptcy due to debt levels that will be impossible to pay back. Moreover, many Americans are aware that future Federal payouts for Social Security and Medicare alone 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 can actually be a very 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 without borrowing. It is easier to accept this premise on the personal or household 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 borrowing more (ie, increasing national debt) to improve their national infrastructure, education, and employment with the end goal of increasing their citizens' standards of living. Thus, hopefully, with a conclusion that debt can actually be a "good thing", if used for productive purposes and managed wisely, one can then proceed to the next section as to exactly what are acceptable levels of national debt for a country.

$18.8T: 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 a major fiscal problem in the United States. The problem is that with the continued rate of growth in the debt, especially as has occurred over the last 15 years, a "debt crisis' could develop meaning that lenders to the U.S. Government could become leery of lending additional money because of the fear of not getting their loan paid back. In addition, a greater loss of confidence by the public in the U.S.'s ability to pay back their loans will cause the Government to have to raise interest rates on any new debt to entice new lenders to take a chance and lend their money to the Government. This raising of interest rates by the Government to obtain new lending will permeate through the economy as private businesses will also need to raise their interest rates to compete with the government in order to obtain loanable funds for their own businesses. These higher interest rates will "crowd out" private business investment (Ig) and reduce economic growth.

Whether it is an individual or a country, the level of debt that one can afford is best measured against one's income. For example, perhaps your parents can afford a debt level of $500K on their homes and cars whereas Donald Trump can afford a debt level in the hundreds of millions! . A country is no different from a household in that debt levels must be benchmarked against income and a country's "income" is called GDP (Gross Domestic Product). Currently, US GDP is $18.4T annually and represents all of the gross income (wages, profits, rents, interests) earned by households and institutions within the United States. In short, GDP or gross income is the tax base or earnings that Congress has the authority to tax against to raise revenue to run the country and pay off current maturities of the national debt. Thus, the key point is that debt must be benchmarked to income, whether a household or government to determine whether that debt is affordable.

The United States debt-to-GDP ratio is currently at 102% ($18.8T in debt / $18.4T in GDP). When comparing the U.S. to other nation's, economists have concluded that the U.S.'s 102% national debt/GDP percentage is, in fact, well above average compared with most modern economies, but it is certainly not the highest as economies like Japan, Italy, and Greece currently have debt/GDP levels at 230%, 132%, and 177%, respectively. Moreover, the level of U.S. national debt today at a percentage of GDP of 102% is still below where it was back in 1945, where it reached 121% after having financed World War II.

So, if Japan's debt is relatively higher than the U.S. at 230% versus 102%, does that mean that the U.S. can afford to borrow a lot more, even twice as much since Japan already has? Not necessarily. A nation can only borrow if the public has enough confidence in the government to pay the loan back. Lenders to Greece panicked once the Greece debt/GDP ratio passed 100%. Spain, currently at a 98% debt to GDP ratio is having a public loss of confidence right now forcing the Spanish government to significantly increase the interest rates that they pay on new debt to entice Spanish lenders to take a chance on loaning the money. The point is that a debt panic can happen at any time and no one can predict when. When it takes hold, the public is no longer willing to loan money causing Governments not to be able to fund their initiatives. Thus, the U.S. needs to be careful! Several years ago, independent debt raters (S&P) downgraded the U.S. government's debt paying ability saying that lenders should start to be careful in loaning to the U.S. government as the debt to GDP ratio was rising too fast and Congress didn't seem to be able to agree on how to stop the unfavorable debt growth. However, recently the U.S. debt rating was upgraded to the highest quality rating once again as US deficits and debt growth have flattened out in the last 18 months meaning the debt/GDP ratio has remained the same. 

 

WHO IS THE NATIONAL DEBT OWED TO?

Much has also been made of the fact that $6.2T of the U.S. national debt, or 33%, 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/loaning 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 the U.S. dollars back to the U.S. Government by purchasing bonds. Most economists don’t consider the fact that debt is “foreign owned” to be a significant problem, as these dollars will eventually be paid back to the foreigners with interest by the U.S. Government and these same dollars will, in turn, be spent back into our U.S. economy. Debt held by foreigners is “dollar savings” by the foreign public 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! Most Americans incorrectly believe, due to the American press and our politicians running for office, that most of the debt is owed to China. This is not true as China holds only 6% of the total debt ($1.2T) and China's share has been constant of late. We actually owe the same amount of debt to Japan, also at $1.2T.

The National Debt Never Has To Be Paid Back!
The national debt collective level never has to be reduced! Many non-economists believe that the national debt total 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 kept at an acceptable level of GDP (100% of GDP would be a good target, in my opinion) and then the national debt must be maintained at that 100% of GDP or less out into perpetuity. This means that the national debt can grow higher nominally each year as long as it does not grow at a percentage rate faster than the rate of growth of our economy (GDP) and tax revenues, which have been historically around a 3% growth rate per year. Just like families growing in household income continue to increase their nominal amount of debt held, Governments can do the same without any risk to their credit rating! Tell this to your parents at the dinner table: "Latter said that the national debt will never be paid back and does not have to be paid back and that it is misinformation that future generations have to pay it back". Yes, when you are my age, the national debt will most likely be greater than $50T and it may be less of a problem/issue than it is today!

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 disastrous levels, potentially 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 (promised) government obligations (over $50T 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 to the current law 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 perhaps re-allocations 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 monitor the growth in the national debt relative to GDP. Most economists would say that the nominal rise in the national debt should be no more than $0.5T ($500B), or 3% of GDP, since it is actually safe for the debt to rise at no greater a rate than the growth in annual GDP. Currently, as of this writing, our annual deficits are growing at exactly 3% of nominal GDP, which is good, and this means that our 102% debt/GDP ratio would stay the same if we keep this relationship, although the debt will still grow nominally at the $0.5T per year. We will see if our President and Congress can make the tough fiscal changes needed to maintain our deficits/debt  percentage at around 100%, so we will not end up like Greece!

CONCLUSION

Today's $18.8T U.S. national debt has risen at too fast a rate. In just 15 years, the U.S. debt level has gone from 58% of GDP in 2000 to 102% today. We can afford to carry a debt load of 102%, and perhaps much higher, but no one really knows when the debt level could cause a panic (like Spain or Greece) throwing our economy into turmoil.

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 as Medicare and Social Security will continue to skyrocket unless changes are made. Medicare and Social Security alone are over 40% of all Government spending so those are the budget areas we need to target. We also will likely need to increase taxes somewhat to help cure the high deficits.

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, the last several years has been a miserable display of Congressional teamwork and effectiveness, in my opinion, as Democrats and Republicans decided not to work together to revamp our social security and Medicare programs, which are the largest portions of the fiscal budget. I hope it does not take a debt panic crisis to significantly slow down the rate of our national debt growth. The good news, though, is that in the last year our deficits/debt has grown in line with nominal GDP which is the ultimate goal. 

The next 5 years will be very important years in our country to establish the fiscal discipline to ensure that our debt to GDP levels remain at current 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. $1.2T of our $18.8T in national debt is owed to China. 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 $18.8T 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. Do either of your parents understand that the national debt levels never need to be reduced (paid back) and that all we have to do is control the rate of the national debt growth to equal to or less than the rate of growth in GDP?

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