by Steven T. Petty, Ph.D., Senior Research Analyst at Pension Consultants, Inc.
INTRODUCTION
This paper examines various aspects of the national debt of the United States in order to determine if it poses a problem to be seriously concerned with at this time. The focus is on U.S. government debt measures. A general overview of budget deficits and government debt is presented, followed by a discussion of how debt data and statistics can be both insightful and confusing to the general public. Also, an examination is made of the levels of government debt over time and across countries. An analysis and conclusion section is presented that answers the title question of the paper.
OVERVIEW
In order to better understand the national debt we need to review the concept of government overspending. Whenever the federal government spends more in one year than it collects in revenues (tax receipts, fees & penalties, etc.), a deficit results. The budget deficit is simply the amount of overspending incurred in one year. The national debt, simply put, is the accumulation of all past deficits net of any budget surpluses (which rarely happen). Why does our government, more often than not, incur budget deficits? One simple but highly plausible answer involves the difficulty in saying no to buy more goods and services – regardless of whether you represent a household, business, or the government. Connect this thought with the reality that members of the U.S. Congress receive votes and political contributions from their constituents and it is easy to understand how overspending now (with immediate benefits and often postponed costs) can trump fiscal responsibility.
In its proper use, government’s economic rationale for overspending seeks to mitigate the effects of a recession by reducing the length, breadth, and severity of the downturn. An economic downturn or recession is a wide-scale problem that results in drops in national income, output, and employment. A recession is often brought on by some form of financial panic and/or some type of strategic supply shock (think oil). At the beginning of a downturn, the general public will typically react by forming a pessimistic view of the near future. As a result, belt-tightening occurs and acquisition plans of all varieties are tempered. Spending, the “lifeblood of the economy” diminishes. Logically, if the economy is spending-starved then additional spending is the immediate prescription needed to set the system back on its feet again. Only the government, with the power to create money, has the ability to overspend in such times. Debt is incurred not to engage in indulgences and otherwise frivolous spending but to avoid human suffering among the hundreds of millions of people that comprise our nation.
Without government stimulus, a recession typically drags on and the void in spending exerts a negative multiplied impact on the economy. More workers become unemployed, additional income is lost and spending falls even more. Depending on the circumstances it could take quite some time for market forces to work through this sort of scenario. However, with government stimulus, a recession can be shortened and its severity diminished. When these actions are successful, our economy can get back on track much quicker. Income, output, and employment all increase sooner than they would have otherwise. With more working people’s incomes to tax, tax revenues expand sooner and greater than they would otherwise.
By helping the recovery to occur faster, government’s overspending can actually provide the genesis for new additional income, and thus new additional tax receipts that can be used to pay down the initial overspending. As the economy continues to grow, government spending can be decreased as private sector spending picks up. The combination of higher tax receipts and lower government spending would serve to bring the budget position back in line. Ideally, a balanced position, on average, over the course of a full business cycle is the goal. Since the 1930s, market-based economies have relied on government intervention to stimulate spending in order to cut short the injurious effects of recessions.
Any examination of government overspending requires a discussion of the long-term effects of debt financing and the viability of balancing the government budget over the course of the business cycle and debt is paid down to negligible levels. To start, government overspending is financed by issuing U.S. Treasury Bonds. When overspending grows, more bonds are issued and the U.S. government becomes a bigger demander in the loanable funds marketplace. With limited amounts of overall savings representing the supply of loanable funds, bigger demand can cause prices of loanable funds, interest rates, to rise. When interest rates rise, other participants in this marketplace, including business firms and households, suffer more than the government. This is because the U.S. government, with the power and authority to create money, can more easily pay higher interest rates and outbid the private sector when competing for funds to borrow. In this age of the modern economy, businesses and households as well as the government look to utilize credit from the marketplace with which to carry out purchases.
The process outlined above is generally referred to as the “crowding out” of the private sector (business and household spending) by the government. Economists do not like to see this scenario play out because it can result in slower economic growth and lower standards of living over time. The government sector growing (as a percentage of GDP) at the expense of the business and household sectors will typically result in inefficiencies that curtail growth and living standards. The government sector is not restrained by a binding budget constraint (again, the power to create money is at play) nor does it operate under a profit motive. Private business firms do operate under a profit motive and thus possess strong incentives to produce worthwhile products and sell them at reasonable prices while keeping costs down. Households likewise operate under incentives that promote good decision-making by virtue of a binding budget constraint.
By examining the incentives, one can logically understand how a growing governmental sector can bid up interest rates and become a drag on the economy at the expense of businesses and households. An outworking of this scenario explains how the private sector can also get “squeezed” by higher future tax burdens. Without the desirable incentives faced by households and businesses, government often fails to balance the budget over the course of the business cycle and government debt begins to mount up. To pay down this debt, higher tax revenue will be needed. Sometimes higher tax rates are used to help secure higher tax revenues. Again, we see how bigger government impinges on businesses and households by taking portions from incomes that normally would have been used to efficiently pursue private sector investment, saving, and consumption activities.
A DISCUSSION OF PERSPECTIVES
In order to better understand the U.S. national debt, it is instructive to note differences in various measures of national indebtedness. Depending on the research or reporting purposes, the choice of indebtedness measure can vary widely. Throughout this paper the term “national debt” is used in a generic manner. The specific meaning at various points in the paper will depend on the context derived from the subject matter at hand.
To start our discussion, this paper focuses on the U.S. Gross Federal Debt measure, which is currently estimated at $13.1 trillion.[1] This figure represents the total or gross outstanding debt generated by our government that is held by U.S. government agencies and the public. In this sense, the “held by the public” portion consists of domestic and foreign lenders alike. U.S. Gross Federal Debt figures are used in this paper to examine our country’s indebtedness over time. Recently, the news media has focused on this measure by reporting that the U.S. Gross Federal Debt as a percentage of U.S. Gross Domestic Product (GDP) has risen to an estimated 89.5% for the current year. Although this measure may appear to be an end-all, all-inclusive debt figure for our country, it isn’t. The U.S. Gross Federal Debt considers only government liabilities that are currently incurred, recognized, and funded. Governmental promises for future spending that are currently unfunded are not included in this measure.[2]
Later in the paper, U.S. indebtedness compared to other countries is examined by using Public Debt estimates available from the CIA World Factbook.[3] As defined by this source, Public Debt equals all government borrowings less repayments that are denominated in a country’s home currency. This definition implies that the Public Debt measure reported by the World Factbook largely represents government debt currently held by foreign parties, although this cannot specifically be verified.[4] The specific reason for using this data is that it is the only readily available source which provides a consistently collected and reported measure of government debt over time. How much of that debt, in an absolute sense, that is held by domestic versus foreign entities is not crucial to the purposes of this paper. Relative comparisons are instead highlighted.
The figures in this paper (2009 and 2008 estimates) are used for comparisons in this paper because they are readily available for use for a large number of countries. Without access to the direct methodology used in compiling the CIA World Factbook data, the Public Debt figures do not translate exactly into more common debt measures at aggregate or sub-levels of an economy. Also, as defined, these Public Debt figures can provide only limited insight on the exact composition of a nation’s government debt. This limitation is unfortunate because it is useful to know the levels of debt held externally because foreign parties are naturally not as likely to grant as favorable debt repayment terms as our own citizens (i.e. if we owe it to ourselves, we will make it easy on ourselves to finance it).
In the coming months, Americans across the entire social strata will no doubt hear more about the national debt and how our government plans to deal with it. It is important to keep in mind that what we hear reported in the news broadcasts, and read in print media concerning our measures of national debt will no doubt not be entirely consistent. The exact nomenclature and meaning surrounding a reported measure will become more important in order to help sort out facts from rhetoric in upcoming elections.
THE U.S. NATIONAL DEBT OVER TIME
As mentioned in the previous section, the current national debt, as measured by the Gross Federal Debt is approximately $13,067 billion (or $13.1 trillion rounded). The current estimate of our nation’s Gross Domestic Product (GDP) equals $14,601.4 billion (or $14.6 trillion rounded).[5] As a percentage of GDP, the national debt currently equals approximately 89.5%. The pertinent question is whether a debt-to-GDP ratio of 90% is so high as to be of serious concern. To help address this question, first the U.S. Gross Federal Debt over time will be scrutinized, followed by an examination of 2009/2008 Public Debt measures across countries.
Since reliable data became available, there have been two time periods in U.S. history during which the national debt-to-GDP ratio (“debt ratio”) has exceeded 70%. The first period was during and after World War II. Table One shows this period starting in 1943 with the debt ratio at 79.1%. By 1946 the debt ratio reaches a peak of 121.7% and by 1954 falls to 71.8% to close out this period of high debt-to-GDP. As mentioned before, this period coincides with and follows World War II. It is interesting to note that the debt ratio did not exceed 70% until 1943 and did not exceed 100% until 1945, the last year of the war. The debt ratio peak did not occur until 1946 when the war was over. Finally, we also observe that the debt ratio remained above 70% for a number of years following World War II.[6]
For a total of twelve (12) years, until 1955, the debt ratio remained above 70%. It is easy to understand how the debt ratio could remain high for a few years after World War II due to the winding down of war-time production processes and re-tooling for civilian goods production as well as for aid payments to war-torn parts of the world. What comes as more of a surprise is that so much of the debt from government overspending comes after World War II ended. Basically, for an entire decade after the war, the National Debt remained at historically high levels. More toward the beginning of that period, there were two years, 1946 and 1950 in which the growth of GDP amounted to less than 1% (0.60% and 0.70%, respectively). Otherwise, for the entire ten-year time period, 1945 through 1954, nominal GDP grew 70%. This growth rate alone is a staggering figure but when coupled with the fact that the Gross Federal Debt exceeded 70% each of those post-war years and actually averaged 93% during that period, we’re able to see what an incredible rebuke this represents to the current idea that high levels of national debt necessarily choke off economic growth.[7]
During the years following 1954, the debt ratio continued to fall fairly steadily, for two and half decades. Supply shocks that led to stagflation for the U.S. during the 1970s appear to have had little to do with the size of the national debt.[8] By 1981, the debt ratio had fallen to 32.5%. Beginning in 1982, the debt ratio began a steady yearly climb until 1997 (rising to 65.6%). From 1997 through 2001 it fell (down to 57.4%) and from 2002 to present day, the debt ratio has risen each year, topping out now at 89.5%.
Table One shows that is was not until 2008 that the Gross Federal Debt once again represented more than 70% of GDP. Estimates provided in the table by the U.S. Office of Management and Budget show the debt ratio rising to 98.1% by the end of 2010, topping out at 101.0% in 2011 and registering at 99.8% for 2014. These are certainly high debt ratios that merit attention. When one ponders over these figures it is natural to conceive of how difficult it is to vanquish debt once it has gained such a large foothold. Nonetheless, one can also observe how the recent high debt ratio figures are not dissimilar from those of the earlier period, starting in 1943. Just as it was in the past, we likely have the means at our disposal to gradually whittle down the debt ratio to more comfortable (less than 70%) levels.
Similarities between the previous high debt ratio period and the present period exist. In both cases, periods of significant armed conflict are involved. Noting this, we understand the costs of waging war are significant and cannot always be financed with current government budget receipts. Along with war, there are rebuilding costs. The United States has shown a willingness to help rebuild Iraqi infrastructure in lock-step with that shown after the end of World War II to European countries and Japan.[9] By helping to rebuild Europe and Japan, the U.S. took a large overspending hit initially but virtually assured itself of political allies and trading partners in the future with healthy, self-sustainable markets.
Additionally, comparable to the time after World War II, much technological advancement exists that is making possible new restructuring, manufacturing, and consuming processes once not thought possible. Advances in computing power, various forms of micro (even nano) technology, instant telecommunications, etc. are making possible “green” and “sustainable” breakthroughs that may well yet come to dominate the course of our economy’s future growth.
In contrast, our present period differs from the post World War II environment. First, the twenty-year baby boom, from 1945 to 1965 no doubt played a significant role in fueling economic growth during that period. In terms of growing consumer demand and additions to human capital, the significant up-tick in population was in sync with two other factors during that time. The war-time rationing and pent-up demands and euphoria at war’s end resulted in savings that translated into an ability and willingness to spend money in the latter 1940s. Combined with government’s much lower level of domestic unfunded liabilities at that time, we can understand how, in hindsight, the ten years following 1945 look more appealing than the ten years ahead of us in 2010.
In short, there are compelling reasons to believe that high debt ratios need not derail future U.S. economic growth. Targeting spending national spending efforts wisely to ensure posterity does not come up empty-handed is the key. As a nation, we do not want to be saddled with high debt loads for too long a time period. Failure to avoid that will most assuredly result in slower economic growth. Profitable private sector ventures should be fostered and not discouraged. Along these lines, future tax policy and the realignment of budget priorities will likely play a large role in determining how successful our economy will be in the coming years in achieving acceptable levels of economic growth.
NATIONAL DEBT AMONG COUNTRIES
Besides examining our country’s overspending over time, it is natural to make comparisons with other countries. As mentioned previously, Public Debt from the CIA World Factbook is a readily available measure, consistently gathered over time, to use in making international debt comparisons. Public Debt equals all government borrowings less repayments that are denominated in a country’s home currency; thus the definition implies that this Public Debt measure largely represents government debt currently held by foreign parties. Again, the reason this data is used is for its value to make government debt comparisons over time (2008 to 2009) and across countries utilizing one data set. Public Debt to GDP ratios (debt ratios) are found in Table Two.
In Table Two, both the United States and the world average are highlighted. The U.S., ranked 42nd highest with a 2009 Public Debt equal to 52.9% of GDP comes in lower than the world average, ranked 37th with a debt ratio equal to 56.0%.[10] Another interesting observation in some cases is the size of Public Debt compared to certain preconceived notions about that country’s economy. For example, the two top-ranked countries are Zimbabwe and Japan. The two countries are number one and number two in their debt ratios and are both small nations in land mass but the similarities largely end there. Zimbabwe possesses a very small-sized and relatively new fledgling economy. Japan’s economy is one of the worlds largest and is well-developed. Both have relatively high levels of Public Debt but for different reasons. Zimbabwe’s small delicate economy relies on the government heavily for most of its GDP in order to provide a host of basic goods and services just to sustain its populace. Japan’s large developed economy has required government intervention to make up for shortfalls in private-sector spending, not because of underdevelopment but in part because of conservative societal mores that result in a high propensity to save income. Largely because of this, government debt and thus Public Debt in Japan is relatively high.
Another observation from Table Two is more telling with respect to the U.S. Public Debt load. All but one of the five so-called PIIGS countries (Portugal, Italy, Ireland, Greece, and Spain) that have made big headlines about their large debt loads are ranked above the United States.[11] Additionally, Hungary is another country in the news recently regarding its public debt woes. Hungary is ranked 16th in terms of its public debt ratio, well above the United States. Furthermore, every single one of the at-risk countries identified above experienced increases in their estimated debt ratios from 2008 to 2009.
Table Two contains some observations that may surprise some people that have formed stereotypical expectations regarding debt and developing economies. Many Latin American countries and other underdeveloped countries that one might reason would be chronically prone to debt are actually ranked lower than the U.S. in terms of public indebtedness. Among these countries are Argentina, Brazil, Columbia, Mexico, and Honduras.
Clearly, Public Debt loads do not paint a complete picture of the risks of indebtedness in an overall sense. Predicting where default problems may arise involves a very complicated set of variables which take into account not only levels of debt but the composition of the economic sectors incurring the debt and how and for what purposes the borrowings are being used. One key takeaway from Table Two is that to date, most of the concern with international indebtedness has been centered on countries that generally have public debt ratios greater than that of the United States and the world in general.
Other important factors to note about the United States are our currency and our economy. Given the history of our dollar currency dominating the post-World War II global economy, the United States does not face the level of exchange rate risk that many other countries must contend with. Possessing the largest economy on the planet, combined with large degrees of market-based freedom, our dollar currency remains a highly coveted asset around the globe. We benefit from this dominance by enjoying high liquidity in our debt financing operations, compared to many other countries. Traditionally, the U.S. has been considered an investment safe haven by our own citizens and foreigners alike. This is largely due to the stability of our democracy and economy as well as the credit-worthiness of our government. Factors that could undermine this stability and credit-worthiness are to be taken seriously. A persistently large and growing national debt could become one such factor.
ANALYSIS AND CONCLUSIONS
Recently, both the size of the national debt and the speed at which it has grown has caused many people to become concerned. To illustrate why, our current estimates of the U.S. Gross Federal Debt as a percentage of U.S. Gross Domestic Product (GDP) suggest a figure equal to 89.5%.[12] Also, owing to domestic and global events of the past few years, including a credit crisis and a major recession, our already large debt load has increased rapidly.
The current U.S. Gross Federal Debt is approximately $13.1 trillion.[13] This compares to a national debt of $9.2 trillion at the end of 2007.[14] This change over the past two and one-half years represents a 42.4% increase in the U.S. Gross Federal Debt. Over the same time period, U.S. GDP rose from $14.337 trillion to $14.6 trillion. This change over the past two and one-half years represents a 1.8% increase in U.S. GDP.[15] Over this time period, the U.S. Gross Federal Debt rose at a rate 23 times faster than that of GDP. Despite the fact that our economy is recovering from a credit crisis and the worst downturn since the early 1980s, this rate of increase merits attention.
A recent study by economists Reinhart and Rogoff suggests that once national debt reaches 90% of GDP annual economic growth falls by approximately 1%.[16] Below this threshold, additional governmental debt does not significantly impact future growth. The study utilized a new dataset for forty-four countries over the span of 200 years. The study also found externally held public and private debt to be more significantly related to growth. The threshold was found to be lower (60% of GDP) and the growth penalty harsher (2% lower annual growth) when compared to those associated with overall national debt.
Reinhart and Rogoff only speculate vaguely and briefly about why a national debt threshold exists around 90% of GDP. This threshold is associated with levels where the national debt begins to be so large that the cost of financing the debt rises. Entities that lend to government by buying government bonds begin to demand discounts to the prices of bonds in order to be compensated for additional risk of default, real or only perceived. With (higher) risk premiums the cost of financing debt increases and cuts deeper into present spending levels, governmental and private, on new goods and services. In this way, debt levels above the 90% threshold can decrease economic growth going forward according to Reinhart and Rogoff.
Without additional research, we can’t be sure what to make out of the Reinhart and Rogoff claims. Despite their findings, we can be at least somewhat heartened by the past experience of U.S indebtedness. Despite incurring high levels of debt (greater than 70%) over a period of twelve years (1943 through 1954) the United States was able to emerge from that episode and proceeded to enjoy an unparalleled period of economic prosperity. This prosperity was even enjoyed while paying down the national debt to GDP ratio to percentages in the mid 30s by the 1970s.
Despite the fact that a large national debt generates associated costs, our economy has shown its ability to meet the costs and utilize the overspending in ways that have resulted in attractive inflation-adjusted growth rates into the future. Additionally, from an international perspective, it is not altogether clear whether U.S. debt levels are horribly out of line in relation to the size of our respective economy and thus our ability to service debt.
Our economy is not far removed from the worst recession in over twenty-five years. Additional injections of government spending may be needed to prevent our recovery from fizzling out. Just as Federal Reserve Chairman Ben Bernanke related in testimony on June 9th before Congress, we should make plans to reduce our budget deficits and the national debt but not implement them immediately. At present, our economy is still very fragile despite having emerged from the recent recession. The economy can ill-afford to lose any spending, public or private, until it becomes clear our recovery is sustainable. Making plans now to ease down on overspending is also wise on account of the specter of inflation manifesting itself once the economy is able to grow more robustly on its own again.
The national debt should be a major concern for all Americans. For individuals investing and saving for retirement it would be wise to explore options that maintain and fortify future after-tax income streams. It is very likely that in the near future the will of Congress will become agreeable with income tax and corporate profit tax hikes to pay down the debt. These and other austerity measures are on the immediate horizon and are necessary in order to prevent the types of calamitous outcomes that have devastated other economies in the past, such as hyperinflation, government debt default or debt restructuring.
For younger Americans, deliberate consideration and planning for the future, going to college, or purchasing automobiles or a home, will all become more important as the new government budget ascetic takes shape.
Clearly, the debt crossroads for our economy is in full view. However, it is likely no major government debt reduction actions will be undertaken until 2011 (a new Congress will take office after the November 2010 elections). Private sector spending, especially from businesses, remains a big question mark at this time. The answer to this question will largely determine exactly when our policymakers will wind down government stimulus spending and focus their attention on deficit/debt reduction. Lastly, it is also clear that the debt situation we face is not unique in our nation’s history. America has successfully paid down the national debt before and, with no small degree of effort, we have the ability to do so again.
[1] The measure Gross Federal Debt, which equals all government debt held by Federal Government Accounts plus all Federal government debt held by the Public, it is often referred to as the “national debt”; in this paper, “national debt” will refer to Gross Federal Debt except in latter parts of the paper where “Public Debt” is used to make cross-country comparisons of indebtedness (defined above)
[2] A truly staggering estimate of unfunded government promises to pay equals $62.3 trillion which, when added to the current Gross Federal Debt comes to 516% of current GDP; source data are agglomerations of collected data from a presentation by Jeffrey Gundlach, CEO of DoubleLine Capital, at the Morningstar Conference in Chicago, IL on June 23, 2010
[3] CIA World Factbook, https://www.cia.gov/library/publications/the-world-factbook/index.html; accessed on 6/30/2010
[4] One necessary exception to this definition exists in the CIA World Factbook data, that being for the United States, U.S. publicly held debt (Federal Gross Debt less that held by Federal Government Accounts) is used as a proxy for Public Debt, the rationale deriving from the methodology under which our governmental debt accounting is carried out compared to other countries
[5] Current U.S. GDP information obtained from National Economic Trends, St. Louis Federal Reserve Bank, June 2010 issue, updated through 6/10/2010, at http://research.stlouisfed.org/publications/net/
[6] Although a somewhat arbitrary level, 70% will serve as our benchmark in this paper for identifying periods of when the national debt to GDP ratio appeared to be at a level unnaturally high compared to years preceding and following those periods
[7] To be balanced and accurate, there were a total of four “high-inflation” years between 1945-1954; the years and accompanying CPI annual inflation rates are: 1946 (8.3%), 1947 (14.4%), 1948 (8.1%), and 1951 (7.9%); however, the average of the CPI annual inflation rates during 1945-1954 equals only 3.62%; historical CPI information accessible at the Bureau of Labor Statistics website http://stats.bls.gov/
[8] Stagflation denotes a period of very high unemployment and very high inflation at the same time
[9] Rebuilding efforts are not to be construed to be limited to Iraq but also extended to other Middle-eastern countries such as Afghanistan
[10] U.S. publicly held debt (Federal Gross Debt less that held by Federal Government Accounts) is used as a proxy for Public Debt, the rationale deriving from the methodology under which our governmental debt accounting is carried out compared to other countries
[11] Spain is the member of this group with a public debt ratio lower than that of the United States, 50.0% compared to 52.9%
[12] This measure, Gross Federal Debt, which equals all government debt held by Federal Government Accounts plus all Federal government debt held by the Public, it is often referred to as the “national debt”; in this paper, “national debt” will first refer to Gross Federal Debt but in latter parts of the paper “national debt” will denote measures of Public Debt (which is defined later in the paper)
[13] Current data/information obtained at http://www.usdebtclock.org/ on June 10, 2010
[14] Historic data/information obtained at http://www.treasurydirect.gov/NP/NPGateway on June 10, 2010
[15] 2.1% increase over the past two and one-half years if using the rounded figures
[16] “Growth in a Time of Debt”, paper prepared for the American Economic Review Papers and Proceedings; Carmen M. Reinhart, University of Maryland and Kenneth S. Rogoff, Harvard University; January 7, 2010 draft copy; although inconclusive, Reinhart and Rogoff speculate that this threshold is associated with levels where national debt begins to be perceived as too large and risk premiums begin to be applied to financing the debt
