$26 Trillion and Counting

By Charlie Bilello

11 Jun 2020

Non-taxable stimulus checks, extra unemployment benefits paying many workers more than when they were working, forgivable loans for small business, grants and loans for large corporations, payments to state and local governments, grants for healthcare providers, and more.

“How are we paying for all of this?”

I’ve been getting this question more and more lately.

The short answer: we’re borrowing the money.

US National Debt crossed above $26 trillion this week for the first time. At the end of February, it stood at $23.4 trillion.

As a percentage of economic output (GDP), our national debt has never been higher.

Why is the ratio going up?

Since 1966, National Debt growth per year has outpaced Nominal GDP growth (8.5% vs. 6.3%), with the gap widening substantially over the past 15 years (8.4% vs. 3.5%).

This has been true during both recessionary and expansionary environments, and both Democratic and Republican administrations.

The one constant has been more debt.

There are two questions that typically arise from any discussion on National Debt:

  1. When are we going to pay it back?
  2. What is the tipping point (when does it become a real problem)?

The first question is easy to answer. We are never going to pay it back. From June 2009 through February 2020, we had the longest economic expansion in US history.

If there was ever a time when a “balanced budget” might have been palatable, it would have been during these years.

But the deficits continued, and US National Debt during this period rose from $11.5 trillion to $23.4 trillion.

Paying down the debt, then, seems to be an unrealistic goal as there is simply no appetite for the short-term pain that would accompany such a move.

A more realistic positive scenario would be for the growth in debt to slow from here while economic activity improves to the point where it begins to outpace the growth in debt. We’re a long way away from that today, but that is the goal.

The second question (what is the tipping point?) is much more difficult to answer.

National Debt becomes a real problem at the point when holders of such debt became concerned about default. When that happens, interest rates on that debt skyrocket, making new issuance unpalatable and payback nearly impossible.

In recent years we’ve seen this story play out in Greece, Argentina, and Venezuela.

Are we anywhere close to that situation in the US?

It doesn’t appear so, with interest rates on long-term US Treasury bonds near all-time lows. During this global economic crisis, investors are still very much viewing the US as a safe haven, even with a Debt to GDP ratio of 121%.

If that sounds absurd take a look at Japan and its 240% Debt to GDP Ratio, the highest in the world.

What are the interest rates on Japanese long-term debt? They are close to 0%, and were negative during the peak of the crisis in March.

So does that mean until we hit the tipping point, which if Japan is instructive could be a long time from now, there are no negative consequences borrowing like there’s no tomorrow.

Not at all.

There is much research suggesting that increasing debt and government spending can “crowd out” more productive private investments and reduce overall growth rates. When national debt crosses above a threshold, research shows, there’s an inverse correlation between the level of debt and the level of growth.

Few seem to be concerned with that today. Instead, the prevailing view is that taking on trillions more in debt is prudent and necessary to save the economy today. We’ll worry about tomorrow, tomorrow, they say.

They may be right, but at some point in the future there will be consequences, and as a country we’ll have to decide if we want to continue on the current path. Until then, see you at $27 trillion.

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