So much is being said about US debt these days – and much of it is bewildering. What is it? How big is it? Why do we worry about it?
Much of the discussion is now related to what we call the US or the Federal Debt. The Federal Debt is really just one measure of the nation’s debt. It does not include any of the debt of private parties. That is, if you borrow $100 from Uncle Bob or $100,000 from a bank, this is not captured in the Federal Debt. Furthermore, if a US corporation sells a bond to a foreigner, this loan would not be captured in the Federal Debt – though it would be part of the nation’s Foreign Debt or Net International Investment position.
The Federal Debt is really a pretty simple and straightforward concept. It is the Federal government’s debt. Any time the Federal Government spends more than it receives in revenue (we also call that a Federal deficit), the government must borrow money to make up the difference (no it doesn’t send Milton Friedman out in a helicopter to spew money). The government borrows by printing and selling government bonds. Each government bond it sells to cover a deficit adds to the Federal Debt. In any year that the Federal Government has a budget deficit, the Federal Debt increases. Since we usually have government deficits each year in the USA – it is no surprise that the Federal Debt has increased over time.
In 1940 the US Federal Debt was $50.7 billion. By 1982 it reached $1 trillion. Ten years later it hit $4 trillion, and by 2002 it was more than $6 trillion. In 2010 it will reach $13.8 trillion and promises to land at $20 trillion by 2015. Woooowwee – I wish that was my retirement portfolio! Slowdown Wally – it isn’t exactly what it seems.
My Dad used to tell us kids that he could buy a Chinese meal in Brooklyn for the family in the 1930s for 25 cents. I used to tell my kids, that I could buy a six pack of PBR for only $1.25 when I was using a fake ID back in the 1960s. The point is that we need to create some perspective for these debt amounts when we make comparisons over time. Most tables will show the debt in terms of current GDP – the debt is in nominal terms (current prices) and so we use nominal GDP (instead of the more popular and svelte real GDP).
In 1940 the Federal Debt was about 52.4% of the size of nominal GDP. Here are the percents for the other years I mentioned above:
1982 35.3%
1992 64.1%
2002 58.8%
2010 94.3%
2015 102.6%
The upshot is that between 1940 and 1982, the Federal Debt got bigger in $$ terms but did not keep up with growth in output and prices. Federal Debt was a smaller share of the economy in 1982 than it was in 1940. Despite rising to a high of 121.7% in 1946 (MY BIRTH YEAR!) and despite a war in Vietnam and a war on poverty – the Federal Debt’s increase was less than the growth of output and prices!
But since 1982 the debt percent of GDP crept higher and higher – meaning the debt was rising faster than the size of economy. The 64% of the economy commanded by the debt in 2008 before the recession got some momentum was thought to be quite manageable for the US. It was not out of line with debt percentages of other stable countries. The 90% PLUS rate in 2010 is in line with other struggling countries today and that is what much of the talk is about.
But what of the talk? The intuition has to do with payback. If my family debt gets too big, then I won’t be able to pay it back. That is a problem for me and it is also a big problem for the joker who lent me the money. But that sort of talk is about individuals. Can we apply this intuition to countries?
Most of the Federal Debt is simply what Americans owe to Americans. A portion of the Federal Debt is owed to foreigners, but let’s ignore that for a minute. If we have more debt in the USA, then the gross debt might become large but the net debt is zero – because we owe it to ourselves. Tax payers might have a liability worth $1 but the people who bought the bonds have a $1 asset.
That makes Federal Debt seem pretty cool, until we notice a couple things. First, changes in the economy may have non-symmetric impacts on debtors and credits. For example, an unexpected rise in inflation really stings creditors while it makes the debtors feel like partying until 6am with colorful hats and noise makers. So even though the net debt might be zero – the existence of a large gross debt implies that there are many macroeconomic changes that could have very significant and negative impacts on debtors or creditors. Without the large gross debt – those things would be much less disturbing.
Second, while the net debt might be zero, once the gross debt gets large enough to where it might not be possible to pay it off – it could lead to social instability as we grapple with political issues about what to do about debt holders who will no longer receive their contracted interest and principal.
So even if we owed it all to ourselves – there would still be problems associated with a large gross debt. But foreigners do hold some of the US Federal Debt. In 2009 approximately $3.6 trillion of the $11.9 trillion Gross Federal Debt was held by foreigners. The implication is that this makes things a little tougher on a country that defaults – we don’t just owe it to ourselves and bringing in the international ramifications means there might be even more negative implications of a default or restructuring. Owing 30% of the total debt to foreigners makes the size and interpretation of the debt more complicated and interesting.
What makes the numbers even more confusing is that I quoted 94.3% as the Federal Debt percentage for 2010 but I have seen many references to a 60.3% figure. That’s a big difference. Both numbers are correct! That’s because I have been quoting above the Total Federal Debt –while the 60.3% for 2010 is for the Federal Debt Held by the Public. That figure is expected by the Congressional Budget Office to rise from about 60.3% in 2010 to about 66.7% in 2020. It was 30.6% in 2007 before the recession and 27.8% in 2002.
The Federal Debt Held by the Public is less than the total debt because some of the bonds sold by the government are purchased by other government agencies and by the Federal Reserve. While the government is obligated to pay back the Total Debt, it is thought that the Debt Held by the Public is more compatible with market outcomes relative to the debt. But let’s face it, whether you measure in dollars or percents; or you measure gross or net; or you discuss total or the amount held by the public – there is no getting away from the fact that the debt has grown. If the Debt Held By the Public does increase to 66.7% in 2020 it will have grown more than twice as fast as the economy between 2007 and 2020.
Let me stop there. There are so many ways to go from here. Let’s see what the comments bring.
Well I only notice the word "inflation" once and that in the context of "inflation really stings creditors while it makes the debtors feel like partying". The problem is that while the creditors may be hurt lots of recent govt actions have been to insulate creditors from that hurt. Lots of the TARP and bailout dollars went to peeps who lent money to other peeps who the creditors perhaps knew could not pay the money back.
ReplyDeleteSo while it may seem like creditors get stuck sometimes govts bail them out. But those bail out dollars have to come from some place, and IMHO there are not really good options to raise that money. If the govt simply prints money inflation often results. If the govt borrows money that often means interest rates go up for private borrowers, which means higher prices for goods and services; which often means inflation results.
One real problem with inflation is it distorts economic decisions. Today lots of peeps are investing in gold as an inflation hedge instead of investing their dollars in companies that produce goods and services; resulting in slower economic growth and most likely higher prices than if companies had the amount of investment a rational economic decision would justify. This can result in a vicious circle of expecting inflation being a self fulfilling expectation.
I can still remember hearing the radio ad "Whats the word, Thunderbird; whats the price, thirty twice" when I was using a fake ID. What was a sixty cents bottle of fortified wine now is a $US5 dollar bottle of wine.
Larry, great post. Folks are getting pretty wound up about the debt. They've been paying attention to what is happening in Greece (and potentially California and other states too). I think B&O (Bernanke and Obama) were hoping that either the stimulus would really work or that they wouldn't pay much attention to debt levels. But the stimulus didn't work because it wasn't designed to do anything but stimulate public sector union payrolls. People aren't fooled, they understand that spending $$$ to fill potholes does not create wealth or permanent jobs. While a well-maintained infrastructure helps economic growth, it does not create growth.
ReplyDeleteAll of this leads me to believe that B&O are counting on future inflation to help minimize the impact of the enormity of deficit spending the past few years (and future years too). Perhaps I'm imputing such rotten motives to B&O. But I don't doubt that they're both well aware that inflation is a net positive for those who favor spending over fiscal constraint.
The inflation bogeyman is what has kept the price of gold elevated after it was driven up by the flight to safety in 2008. If some of this uncertainty is ever resolved, gold will drop quickly as assets are moved into real investments.
Tom,
ReplyDeleteThis post is supposed to be about debt -- not inflation. I was making a point about net versus gross debt. It is possible, even if net debt of a country is zero, that the gross debt could be a big problem. One example has to do with the way that unexpected inflation differentially affects debtors and creditors. If your comment is to emphasize that current policies might be underpinning higher inflation and poor resource allocation -- then I would not disagree with you. As for the wine example, I am guessing you have moved on the better wines.
Thanks John. I think G&O (I prefer to blame Geitner on this topic) weren't worried about financing the debt. I don't think they gave it much thought as they rode in on matching ponies to save the day with stimulus/bailouts. But that was more than a year ago. The US seems to be the only country continuing to ask for more stimulus while paying only very minor lip service to debt and deficits. The debt is important enough according to G&O to put it off to after the next elections and after just about everything else on their agenda.
ReplyDeleteOne of my colleagues pointed out that I made a big boo boo in my post. So let me correct it. Debt held by the public includes bonds held by the Federal Reserve and the rest of the public. So Debt Held by the Public includes what the Federal Reserve is holding and thus overstates how much the government actually owes to private entities.As of 2009 the debt held buy the non-Federal Reserve Public amounts to 47.6% of GDP -- up from less than 30% in 2002.
ReplyDeleteDear Stu . . .
ReplyDeleteAlways enjoy your succinct easy-to-understand stuff. Now that I feel all good and squishy about who owes what to whom and the amounts, I ponder how and when the debt will be repaid and at what cost. BTW, not mentioned was the off-balance-sheet borrowing from Social Security (you know, that ol lock box of Al Gore’s). Clinton reduced debt by increasing taxes and fortunately enjoyed phenom revenue from short-term cap gain taxes generated by stock traders frenzy as dot.coms exploded (then imploded). OB unfortunately will repeat Clinton’s tax hikes on steroids but will not enjoy much bump from short-term cap gain tax in spite of his impending increase thereof. (And, he won’t get much of a bump from exports despite his “business-friendly” blabber.) On the contrary, his stimulus/bailout will continue to hang over the economy like a hangover, his higher taxes will suppress economic growth, and we taxpayers (and future taxpayers) will be stuck with repaying ourselves and furaners – possibly with slightly inflated $$ – but at a killer cost as the amount of interest on that debt bloats. Add the amount we taxpayers need to put back in Al’s lockbox and we’re not even gunna have ‘nuff change to buy cheap socks from China or even ol Thunderbird (what’s the price now?). Good ol standard of living will tank below Haiti’s . . . . and without an earthquake, too . . . but rather from a debtquake.
Let’s hear how the wealth-producing sector of our economy can produce enough to not only support the non-producing sector but also repay the principal and interest.
Charlie,
ReplyDeleteI can't argue with anything you said. I agree that my post didn't bring in the full value of the debt and that the pile is even bigger than I indicated. I also agree that it is going to be a really big challenge to deal with the payoff. What I can't understand is how or why our government is ignoring this elephant in the shop. The commission will report its findings AFTER the next election. That suggests a lot of urgency, eh? Reminds me of the joke about the guy who jumped off the top of a very tall building. Someone leaned out of the fourth floor and asked him as he went by how its was going. He said, okay so far.