The National debt is rarely a riveting topic that one looks forward to as part of, say, your average dinner table conversation. When the topic comes up it seems to stir the passions of even the most typically genial conversationalist. However, many of the ideas we often take at face value regarding national debt, the economy, and how nations function don’t necessarily stand up to practical realities. Whether the result of framing our understanding of economics with the context of our own personal financial situation or simply our lack of desire to dig deeper into the question of why any particular viewpoint holds water, it’s not difficult to find agreement with a sound bite that sounds good yet carries little authority. Here are five common statements about debt often floated today and why they might not be as accurate as they’re often made out to be.
The United States is drowning in debt.
In 2017 the US national debt topped $20-trillion for the first time. This is, without doubt, a fairly stunning figure especially as it’s never been seen in the life of our country. However, it’s important to consider whether, on a nominal basis, the US debt will always climb to a higher level.
Our economy naturally grows over time thanks in large part to the Federal Reserve’s dual mandate to target full employment and stable prices. The Federal Reserve interprets the long-term beneficial inflation rate to be around 2%. Since the government is, in effect, targeting ever higher prices over time it means that all things pegged to the dollar will, over time, be higher dollar-to-dollar than they were in the past. It’s why the stock market goes up in the long-term, house prices increase, salaries increase, federal budgets (and deficits) increase, and ultimately the federal debt level increases.
However, one measure that helps to strip the effects of inflation is the debt to GDP ratio, where the GDP is a measure of the value of all goods and services produced by the country. Or, in a way, the taxable capacity of the country. By this measure, the US does appear to be worse off than it has been historically, standing at just over 100% (St Louis Fed, debt to GDP data). In recent history, before the Great Recession, the figure stood consistently under 70% and prior to the 1990s was often under 50%. However, our current situation, after the Great Recession and in the midst of a global conflict against terrorism, might be more likened to that of the post-Depression and World War II era. It was during this time that the US Debt to GDP ratio surged to over 110%. While it did eventually take 30-years for the ratio to normalize it did so almost exclusively through growth in GDP rather than any significant reduction in the debt levels. In fact, over the course of this time, the debt level actually doubled (Council of Economic Advisers, Table 7.1).
We should “pay off” our debt.
There is some popularity to the idea or headline that the US ought not be indebted to anyone. In effect, this idea imagines that we should operate the country on a “cash envelope” system which utilizes only the current income in any given year to afford the expenses committed to by the government. However, one must contend with the fact that a nation and a household are, in reality, massively different in form and structure.
A typical household is quite confined in its ability to hold and maintain debt by a few important factors: its income, its use of debt, and its lifespan.
First, a household is dependent on income to pay its debt. Unlike the government, a household has little actual control over its income or, due to inflation or deflation, the real value of this income over time.
Second, much of the debt utilized by an average household goes to liabilities rather than productive investments. When a household purchases a house with a mortgage, a car via financing, or consumable goods on a credit card these items are simply depreciating, at best, or become consistent liabilities at worst. The purchase of a car, for instance, carries with it the additional liabilities of tax, insurance, maintenance, etc. So while some of these items may be necessary to produce income they are still considered liabilities.
Finally, individuals have a very fixed lifespan with which the debt must be paid off, as most lenders take this natural lifespan into account when they consider offering credit. And, if an individual should find himself expired before his debt the creditor will be all too happy to collect the remaining balance or equivalent assets.
In comparison, the federal government is near completely the opposite in all of these regards.
First, the government controls its own income base. While the hurdles to doing so are high and the effects may be counterproductive, the government controls the income it receives from its tax base. If it chose to do so, with the stroke of a pen, the debt situation could be drastically changed with reforms to tax rates and deductions. The government also controls the very value of the dollar with which it pays its debt. In this way, the government can, in effect, change the actual value of the debt it owes by influencing the inflation or depreciation rates of its own currency.
Second, when the government utilizes debt it is the result of running a budget deficit. These deficits exist because the government has committed to its people goods, services, or tax deductions which all theoretically benefit the public. The money spent, or provided via deductions, becomes available to spend and invest within the nation’s economy thus actually increasing the GDP and taxable base. The debt, therefore, can in many ways become an investment in future revenues.
Finally, the government is drastically different from an individual in the fact that it doesn’t have any definitive lifespan. In fact, the government has the unique ability to simply pay the interest due on its debt and, when the final principal payment comes due, roll that debt into a new term. Therefore, the government has the potential to never actually pay off its actual debt, this is most similar to an individual taking an interest-only loan and refinancing it perpetually as the principal comes due.
The fix to our debt is the government spending less.
When it comes to personal finance there is little doubt that the best and most prudent avenue for most people is to pay down most, if not all, of their debt and position themselves to be in a place of relative financial freedom. Because of this, there is a common image that the most prudent thing our government could do in its financial situation is precisely the same. If we were no longer indebted to anyone the country would be free to invest to a greater extent in itself and for the good of its citizens. But, the nation’s debt reflects, to some extent, investment rather than simply fruitless spending.
The natural response to this, however, is the question of whether or not taking on more debt is worth the investment we’re making. Would it simply be better to live within our country’s means?
One of the critical issues with this question is the assumption it makes that our current spending situation is the result of government spending run amuck. It conjures up images of overstaffed national parks, offices with employees sitting idly, bridges to nowhere, or government facilities with expensive and ornate features like Tiffany chandeliers and gold adorned bathrooms. But anyone that’s visited a government office, national park, or tried to get anything done by any government services knows that these ideas are hardly reality.
If this is the case, where are trillions of dollars of our national budget, and therefore our debt, going?
In actuality, our government spends relatively little on administration, services, and “stuff” in comparison to its total spending. In fact, it breaks down like this:
Of the total spending in 2016:
65%: Mandatory Spending (Social Security, Medicare, veterans benefits, etc)
29%: Discretionary Spending (15% of which is military versus 14% for all other services/programs)
6%: Interest on Debt
What does this mean practically? In effect, the vast majority of our budget is allocated to mandatory spending via programs and entitlements which benefit the citizen base directly.
China owns “too much” of our debt.
Who owns the debt issued by the United States? The answer is just about everyone. The roster of our debt holders includes; a majority of the world’s nations, institutional investors, individual investors, pension funds, the Federal Reserve, and, oddly enough, our own government balance sheet.
Over the course of recent history, Chinese manufacturing and exports have become in high demand for the developed world. This has resulted in China becoming the most significant trade partner for the United States, resulting in around 15% of our annual trade. But our trade with China is far from equal. In fact, we import from China significantly more than we export to them. This trade imbalance leaves China with a significant amount of surplus dollars in their system (due to their exports being sold to the US in dollars but not enough imports being brought in to offset this amount). As these dollars are exchanged for local currency through the Chinese banking system the central bank is left with surplus dollars that must be held somehow. Exchanging these dollars for US debt is the most efficient use of these dollars as it effectively allows the return of these dollars to the US while at the same time hedging some of the nation’s trade by holding investments which pay the country back in the currency with which that trade is conducted in.
China holds about 5.5% of our outstanding debt.
In comparison, during multiple rounds of quantitative easing to combat the Great Recession our Federal Reserve bought around $2.8-trillion of our nation’s debt, compared to China’s holding of $1.1-trillion, amounting to 14% of our outstanding debt.
What does this all mean? In effect, our own Federal Reserve Bank has 2.5-times greater influence and effect on our debt situation and yet these two parties still account for only 20% of the total debt outstanding.
This means that in all reality China, though topping the list of foreign holders, is not any more nefarious in its owning of our debt than our own central bank.
The debt doesn’t benefit me.
Likely one of the most misunderstood areas surrounding our debt level is the idea that the majority of our debt goes to the benefit of “them.” That is, some other person, corporation, or interest group.
The fact is that, at 65% of our annual budget, the entitlement programs which nearly every American depends on and benefits from are the greatest contributors to our debt situation under current conditions. The reason for this situation is varied but the result is clear, we are in debt because we have and continue to commit to paying people more out of these programs than they could ever hope to contribute. For a long time this wasn’t actually a problem since as a growing workforce of baby boomers contributed a more and more into the system. However, as we crested the baby boomer wave our nation’s workforce has decreased and the amount of retirees drawing benefits has increased. This budget gap has become the chief contributor to the national deficit.
So, before we attack the irresponsibility of our nation’s debt we must first reconcile the fact that it is due in large part to the fact that we are attempting to support the social security and healthcare of millions. The value of these programs and what they should cost us as a society are some of the key points we must consider as a nation going forward when considering our fiscal situation.
While our national debt is massive, in nominal terms, it may not be as immediately dire as headlines often read. It is certainly important that our country maintains a level of debt that is reasonable and sustainable relative to our nation’s fiscal capacity. However, the measures of what is reasonable and sustainable are often varied and interpretive.
It may be more useful for us collectively to take a hard look at our nation’s budget and reflect on whether it represents our national values. It’s also important to consider what our lawmakers are doing to stimulate real economic growth which results in an expanded tax capacity. Regardless of what stance one takes it’s critical to understand how these five misconceptions can frame our understanding of the issues and, therefore, our understanding of the solution.