“Debt” is one of the most frightening words in the English language, conjuring up visions of peonage, deprivation, and prison. Caricatures of debt collectors, such as the mafia shark who breaks the legs of delinquent borrowers, or Shylock, the moneylender of the “Merchant of Venice” who required a “pound of flesh” as security on a loan, haunt our dreams and reinforce Benjamin Franklin’s advice that one should “rather go to bed without dinner than to rise in debt.”
The idea of the United States Federal Government borrowing is particularly scary, triggering images of “foreigners” taking over the country and foreclosing on valuable assets. It’s easy to forget that credit and debt have been the basis of trade for more than 5,000 years, even before the appearance of money.
The Power of the Federal Government to Incur Debt
Congress was given the power to borrow money on the credit of the country under Article 1 Section 8 of the U.S. Constitution, and has liberally used this power since 1791. In fact, since that time, there has been only a single year – 1836 – during which there was no federal debt. The level of debt rises and falls depending upon whether there is an annual budget surplus or deficit. But debt has generally been on the rise since 1974.
Some analysts claim that the debt is a “ticking time bomb” that will lead to the collapse of the economy, higher unemployment, and drastic cuts in future government services and programs. Others are more sanguine, expecting the debt level to recede as the economy improves, foreign wars end, and unrestrained growth in healthcare is curbed.
But many questions remain: What are the facts? How worried should you be about your future? Is your generation passing on an unconscionable debt to your children and grandchildren?
The U.S. Federal Debt Today
In early November 2012, federal debt was more than $16 trillion, a number so large it is difficult to comprehend in everyday experience. The national debt is so large, in fact, that repayment would take:
- 512 Million Years at a Rate of $1 Per Second. In other words, if dinosaurs had been making these payments, more than half of the outstanding balance would remain unpaid.
- All of the Gold Produced in the World to Date. At a gold price of $1,681.80 per troy ounce, the federal debt is equivalent to 9,652,726,026 troy ounces. Geologists estimate that all gold produced in the world to date to be around 10 trillion ounces.
- Almost All of the Recoverable Oil Remaining in the United States. The debt is equivalent to approximately 191 billion barrels of oil at $85 per barrel. The U.S. Energy Information Administration estimates “technically recoverable reserves of 218.9 billion barrels” for the country today – or about 27 years’ worth of consumption at the current rates.
These examples suggest that the current situation of the United States is very bad, and the country is headed over the fiscal cliff unless immediate steps are taken to pay down debts.
However, when looking at such large numbers, it is helpful to have a different perspective to get a true picture. For example, the United States has the following attributes when compared to the rest of the world:
- Largest Economy. The U.S has the largest economy in the world with a gross domestic product (GDP) estimated to be more than $15 trillion for 2012, about as large as the combined total of the second- (China), third- (Japan), and fourth-largest (Germany) economies of the world – and the United States is still recovering from the effects of the 2009 worldwide economic collapse.
- Richest Citizens. The United States, according to Forbes in February 2012, is the seventh richest country per capita in the world, even though it has the world’s third largest population with more than 300 million people. The next most populous country on the list, the Netherlands, has less than 17 million people. Qatar, number one on the list, has a population that could live comfortably in Philadelphia.
- Large Asset Base. Total financial and non-financial assets of the United States were estimated by the Federal Reserve to be more than $250 trillion; tangible assets (real estate and equipment) added another $56 trillion in 2010. Considering all liabilities of the country, the Federal Reserve projects a net worth of more than $75 trillion for the country (total assets subtract total liabilities equals net worth). Since few countries are as transparent with their economic figures, it is difficult to draw true comparisons, but it seems safe to assume the United States’ asset base is the greatest in the world.
- Most Attractive Business Environment. The U.S. remains one of the most competitive nations in the world, according to the World Economic Forum, ranking seventh in its 2012-2013 Global Competitiveness Report. The same report ranks China, considered by some to be the next “great economic rival,” 27th on the list. Of the nations ranked ahead of the U.S. in the report, the largest, Germany, has a GDP one-quarter the size of the United States. The U.S. is the world’s largest manufacturer, producing about one-fifth of goods manufactured in the world, despite the belief of many that all of America’s manufacturing jobs have moved offshore.
- Best Credit in the World. U.S. government debt is considered the safest in the world even following the debt ceiling debacle of 2011, with virtually no rival for its position. Foreign investors, particularly China and Japan, now own more than $5 trillion of the debt and continue to be eager purchasers of U.S. debt, with interest rates at less than current inflation rates. In July 2012, China and Japan increased their ownership of U.S. securities by $2.6 billion and $7 billion, respectively. Foreign investors as a whole purchased nearly $74 billion of American debt that month.
Simply stated, America is the greatest productive engine the world has ever seen, with unmatched economic, financial, and social assets.
When Is the National Debt Too Great?
While the country’s debt continues to be attractive to buyers both domestic and foreign, there are disadvantages and dangers if the debt becomes too large. The disadvantages of too much government debt can include:
- Calamitous Competition With Private Industry for Funds. There are finite funds available to all borrowers – government or private – at any given time. More entities competing for those funds (in other words, more demand for credit) drives up interest rates in order to attract more capital. As a result, it becomes more difficult for borrowers to obtain funds for growth or to maintain existing production.
- Higher Taxes and/or Service Curtailment. When interest rates rise, countries must devote more of their annual incomes to servicing their outstanding debt, which results in either raising taxes or cutting government expenses, often popular social programs.
- Loss of Market Competitiveness. As the costs of production rise from higher taxes and labor unrest, a country’s products become less attractive to domestic and foreign buyers, triggering a downward cycle of economic and financial catastrophes.
- Economic Malaise. When countries are forced to cut social programs and raise taxes, economic recession and social upheaval generally occur. Unemployment rises as businesses fail, a cycle that can continue for years, and even for decades.
Most economists are concerned with the trend in national debt levels, rather than its actual amount. For years, the country has had expenses greater than revenues, borrowing from the future to pay for the present. The concern of economists is heightened since most American expenses are consumption-oriented, rather than investment.
The U.S. has deferred maintenance of its infrastructure, postponed needed improvements in education, energy, and technology, and delayed fixing the national healthcare system, opting instead for tax cuts, costly nation-building, and expensive, unnecessary subsidies to entrenched influential interest groups. If not slowed or halted, the current trend of ever-increasing debt will deprive future generations of Americans of continued world leadership, economic success, and personal freedom.
Historic Levels of U.S. Debt and the Debt-to-GDP Ratio
Economists generally analyze government debt by comparing the total amount of debt to the country GDP. For example, if debt was $10 trillion and the gross domestic product was $15 trillion, the ratio would be 66.7%.
Following World War II, the ratio for the United States peaked at 112% in 1945 (the country owed more than it produced in that single year of production) and subsequently declined to a low 24.6% in 1974. The ratio then began a steady climb to 49.5% at the start of President Clinton’s first term, fell to 34.5% by the time he left office, and has escalated since. As a result of the policies of Republican President George W. Bush and Democratic President Barack Obama, the debt-to-GDP ratio had climbed to 94% by the end of 2010.
U.S. Debt Compared to Other Countries
When compared to other large industrialized countries on the same basis (debt-to-GDP), only Japan and Italy have higher ratios than the U.S.
Japan, with an astounding ratio of 225%, continues to suffer from a recession following the bursting of its real estate bubble in 1991, exacerbated by the world’s recession in 2008 and a continued lack of consumer confidence.
Italy has a debt-to-GDP ratio in excess of 118%, and is struggling to impose various austerity measures to continue its membership in the Eurozone. At the end of 2010, the ratios for France, Canada, the United Kingdom, and Germany were 84.2%, 81.7%, 76.7%, and 75.3%, respectively, although each ratio increased subsequently in the global economic slowdown.
Optimum Level of National Debt
Most economists agree that debt-to-GDP ratios above 90% are harmful to economic growth, primarily for the uncertainty they create in consumers’ minds. Some economists have suggested that negative economic effects begin as the ratio passes 80% debt-to-GDP.
As a consequence, no respected economist would suggest that the current U.S. debt-to-GDP ratio is sustainable long term; the debate centers over which measures to take to reduce the debt ratio and the period of time over which the measures should take place. The proposed solutions are further complicated due to the recent financial catastrophes in the U.S. real estate and banking sectors and the current global recession.
A Word of Caution
When analyzing national debt, economists usually limit their subject to the actual debt issued by the government or its agencies, not potential debts which may result from guarantees of the Federal Government, such as federally-backed mortgage loans. In addition, unfunded obligations to programs like Social Security, Medicare, and Medicaid are excluded except for the immediate year in which they are incurred.
While the potential liabilities from such guarantees and obligations are substantial, the actual likelihood of being called upon is relatively low from a risk perspective. Furthermore, programs such as Social Security, Medicare, and Medicaid can be amended to increase revenues and/or reduce expenditures, thereby eliminating long term potential liabilities.
The Outlook for a Lower Debt-to-GDP Ratio
The national debt ebbs and flows depend upon the annual deficit or surplus the U.S. has each year in the budget. Simply put, when taxes are high enough to cover or exceed government expenditures, national debt remains level or decreases. When taxes are less than expenditures, a deficit occurs and national debt goes up.
The increase in national debt in the last 12 years is the direct result of reducing taxes (commonly referred to as the “Bush tax cuts”) and increasing expenditures (wars, prescription drug coverage in Medicare, and bailouts of the banking and automobile industries). The gross domestic product in the year 2000 was slightly less than $10 trillion dollars, with a national debt of $7 trillion. Even though GDP has grown 50% during the past 12 years, federal debt has more than doubled, the direct result of elected officials being unwilling to confront their constituencies with the hard truth: There is no such thing as a free lunch.
Projected GDP Growth and Budget Deficits
In January 2012, the Congressional Budget Office (CBO) projected continued – though declining – budget deficits through the end of the decade with slower domestic economic growth, continued unemployment of 7% to 8%, and a worsening of the European banking and fiscal problem. Even though various economists predict a U.S. GDP slightly above $20 trillion in 2020, equivalent to an annual growth rate of 2.84%, the CBO expects a debt-to-GDP ratio of 90% in 2020.
The continued deficits are the consequence of extending the Bush tax cuts for families making less than $250,000 per year, and eliminating scheduled changes in the alternative minimum tax. According to Douglas W. Elmendorf, director of the CBO, “Those changes reduce revenues by a total of $3 trillion through 2020.” The CBO figures do not anticipate changes in tax or spending policies, which may be implemented in future years to eliminate future deficits or reduce national debt.
Even though U.S. taxes at all levels of government are less than other industrialized countries (25% of GDP versus an average 35% for the 33 members of the Organization for Economic Cooperation and Development), Americans’ desire to reduce taxes – or, conversely, their unwillingness to increase taxes – is likely to prevail short of a national emergency.
At the same time, the population is growing older, driving up healthcare and retirement costs; the country’s infrastructure is aging and needs replacement and repair; and America’s security is threatened by extremists and terrorists. It is difficult to foresee significant reduction in popular entitlement programs. While the end of two wars, slowed growth in the cost of healthcare, and an economy beginning to recover will reduce the projected deficits, it is unlikely these factors alone will be enough to reverse the long-term trend of national debt increases.
Conversations and concerns about a multi-trillion-dollar national debt can seem trivial and inconsequential to a family worried about losing jobs or paying for college. It’s hard to think about retirement 20 years into the future or care whether the governments of China, Japan, or Germany buy U.S. government bonds when your home is valued at less than you paid for it, and you’re paying $4 for a gallon of gas.
Yet the decisions made by Congress on your behalf can have drastic adverse effects upon your life today, your life in the future, and the lives of your children. You need look no further than the countries of Greece, Spain, and Italy to understand the negative effects of too much government debt.
At the same time, draconian measures to cut government programs or dramatically increase taxes could cut off the legs under a nascent economic recovery just beginning to expand. Many economists believe that Japan’s “lost decade” of the 1990s was the result of austere government policies and failure to stimulate the recovery after the bottom of the cycle was reached.
I believe President Obama’s proposed approach of extending tax cuts to all but the highest bracket of taxpayers while investing in infrastructure projects and education is the proper course today. Government expenditures to employ thousands of people in needed long-term projects – workers who will pay taxes, buy goods, and give private businesses reasons to invest in their own companies – makes sense. Simply treading water with the status quo or risking another recession seems foolish.
How do you feel about higher taxes? If government programs should be cut, which ones?