By Charlie McMillan Summons
Should we Worry?
America’s public wealth is negative. If Washington were to liquidate all public assets tomorrow, it would still owe money to creditors. In fact, America as a country is indebted to the tune of US$25 trillion (AU$38 trillion). While this certainly does not sound promising, it is not as dire as it might sound. This article will put into context the trillions of dollars the US government owes in public debt. It will show that this big scary number is not, in fact, so big and scary. However, it will also identify some major reasons to be uncomfortable about the situation.
America is not a Person or Corporation
Public debt can be rolled over much more freely than private debt. Say someone buys 30-year US treasuries in 1950. That debt does not have to be paid off per se. The bondholder will expect her principle back with interest but that does not mean America has to fully pay off that debt. The nation can borrow more money, pay off that 30-year treasury bond sold in 1950 and keep on rolling.
I can’t do that because banks eventually question whether a partially employed student will be able to pay back that loan that I have been jumping to different lenders with. No one – at least no significant amount of people – have seriously questioned America’s ability to satisfy their debts just yet. Indeed, the goal is not to pay off the country’s debt to a zero balance.
America also has access to the tax receipts of an extraordinarily large economy which, thus far, continues to grow. With the right political will, this economy could be taxed at a higher rate.
The difficulty is that the US’ population is not growing as quickly as it once did. This necessarily hinders increases in output. In 2019, the rate of population growth sat at 0.48%. This was the lowest annual growth, coincidently, since 1918 when the Spanish Flu was circulating. For reference, the average annual growth rate since 1909 (when population statistics began in the United States) has been 1.2%. Productivity will need to pick up the slack. There is great potential to do so with production automation and advances in computer science. But, equally, it has been suggested that countries with low minimum wages dis-incentivise R&D in this technology. Fully automating a production line looks extremely expensive when cheap human labour is readily available.
Since the end of World War 2, nominal GDP has grown at the same annual rate as government debt. This has the effect of keeping the debt-to-GDP ratio down (discussed below) Whether there is another century of continued expansion is another, much more uncertain question. In any case, perpetual growth is a delusion so it is unlikely that the US can grow its debt ad infinitum.
What makes debt worrying day-to-day is the interest the borrower must pay. Interest payments redirect government funds away from public works and other spending.
In the 2018-2019 annual US federal budget, 8.7% of all government spending went to paying bondholders. For reference, France spent around 30% of its GDP on interest annually in the years prior to the Revolution. This was in large part due to the (justified) high rate of interest creditors demanded when lending to Louis XVI. Although public debt-to-GDP sat around 56% in the 1780s, the French government was paying 7.5% interest rates. This was double what Great Britain had to pay at the time.
Currently, 30-year treasuries are trading with coupon rates of 1.44%. Such low annual repayments enable America to take on so much debt. A more extreme example of this is Japan whose debt was 238% of GDP in 2018 but whose interest expenses account for only 9.4% of government expenditure (as of 2017) thanks to low interest rates. Of course, economies are complex adaptive systems so there are a multitude of consequential effects and interactions Japan’s debt load has had.
Related to interest coverage is the debt-to-GDP ratio. As of 2019, the US debt-to-GDP was sitting just shy of 107%. For reference, Australia’s gross public debt, as of the end of 2019, sat at around 41% of GDP. The US’ (as yet) unrepeated zenith of around 120% occurred due to the cost of financing World War 2. It is worrying that prior to the Covid-19 crisis, American debt levels were already above 100% of GDP. This is in spite of the fact that, prior to coronavirus, America was not financing a project on the scale of World War Two.
Covid-19 has already or likely will push debt-to-GDP to 120%. The reason is twofold. Firstly, the huge stimulus spending already enacted will increase the US’ debt load (the numerator). There will also be more stimulus as a likely second wave affects the country. Secondly, GDP (the denominator) will shrink as a result of the economic pause in states which have issued stay-at-home orders. The US Bureau of Economic Analysis is predicting a 4.8% contraction of GDP in Q1 2020.
For comparison England bore an excruciating debt load after the Napoleonic Wars. It was indebted to the equivalent of two years of national income. It took a century (1814-1914) of paying bondholders a third to a quarter of annual tax revenues for the debt to be repaid. This would not happen nowadays. In this period in England, suffrage was only afforded to the wealthiest men who themselves were the bondholders to England’s debt. In effect, it was in their interest to not inflate away the debt and steadily use middle- and low-income taxpayers to repay their debt instruments.
So, when someone in your next Zoom hangout comments that US debt is an obscenely large number you can remind them that there are a lot of large numbers. The key thing to examine in the case of the United States is the Debt-to-GDP and cost of covering interest repayments. If growth in debt outpaces growth in GDP, the US will likely slip further into debt. Interest coverage is highly influenced by the level of faith in the US’ ability and willingness to repay. The USD being the world’s reserve currency certainly helps. If enough people lose faith, all things being equal, interest rates on treasury bonds will rise and so will America’s interest payments.
Thomas Piketty, Capital and Ideology
Financial Times Alphaville
World Economic Forum
Sobotka, Tomáš, Vegard Skirbekk, and Dimiter Philipov. “Economic Recession and Fertility in the Developed World.” Population and Development Review 37, no. 2 (2011): 267-306.
Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a professional before making investment decisions based off of this article.