Tuesday, September 26, 2017

Happy Birthday to the National Debt

Let’s call her Natty. Natty just reached 20 -- $20 trillion that is. Okay, it’s not a birthday but it is a milestone and one that bears a little time and attention.

There are so many things to say that I don’t know where to begin.

Let’s think first about the words “national debt.” Natty is most definitely not a measure of all the debt of the nation. Households have many kinds of debt and none of them are included in the $20 trillion national debt. Borrowing money for houses, cars, JD, and college are not part of Natty. All that credit created by slipping your credit card into a little machine is not included in Natty. That loan to Uncle Chuck isn’t part of it either. And when companies large and small borrow from banks or sell bonds or find other means to finance their acquisitions of plant, equipment, and software – none of that is included either.

So what is included in Natty? Natty is simply the debt owed by the federal government. Notice that Natty does not include any borrowings of your state and local governments. Natty’s $20 trillion pile of debt includes only that which the US federal government borrowed.

Why does the government owe any money? Doesn’t the government have the power to tax us? Surely there are plenty of federal taxes. The truth is that the government owes money because, like the Tuna, it loves to spend money and hates to ask us taxpayers to pay the whole deal. Take 2016 for example. The government collected $3.3 trillion in tax revenue. On Social Security, Medicare, defense, and many other programs, it spent approximately $3.9 trillion. Thus the government had to borrow $585 billion to meet the difference.

Why did the government have to borrow that money? Doesn’t the government have the power to print money without limit? In most countries, including the USA, a central bank exists and it is allowed to print money. But budget deficits must be funded by government borrowing through bonds. Clever governments ask central banks to buy their debt and that eases the process. But as we will see below, most of the debt is held by private investors.

In 2016 the government borrowed $585 billion. That’s a long way from $20 trillion. How did the debt get so large? The answer is that the US government is addicted to debt. In the 49 years between 1967 and 2016, the US had a surplus only five times. Thus we had deficits and we added to the debt in 44 of those 49 years. That’s how the debt got so large. We piled up almost $8 trillion of the $20 trillion in the nine years since the great recession started in 2008. While the additions to the debt have been somewhat less lately, we had at least three years in which the annual deficits were well over $1 trillion per year.

Who holds the national debt? I heard China has a lot of it. Let’s start with the 2016 national debt of $19.6 trillion. Of that amount, $5.4 trillion was money that some parts of government owed to other parts of government. So we call the public debt the remaining $14.2 trillion. Of that amount, the Federal Reserve owned $2.8 trillion. That left $11.7 trillion for private investors. Of that amount, Chinese and other foreigners owned $6.2 trillion. 

Is that $6.2 trillion enough for foreigners to push the US around? I doubt it. But in the event that foreigners decided to quickly sell all their US bonds, that could throw us for a loop. But keep this in mind, if any investors in US bonds decided they are a risky bet – it doesn’t matter whether the sales come from foreigners or US citizens – the results could be terrible.

This leads us to the big question: Does the $20 trillion debt put the US in a risky position? The government is a pretty big cat; is $20 trillion a lot of money? Here is where an example might be helpful. Suppose you have debt of $100,000. Is that risky? It depends on your ability to pay it off. Maybe you have a savings account of $3 million. Not so bad. Maybe you have an annual income of $300,000. Not so bad. But if instead you have no money in the bank and you have a very low income, then your bank is going to worry about your ability to repay the $100,000.

Similar ideas apply to countries. How do you measure the ability of a country to repay its debt? We might look at foreign reserves they accumulated to pay foreigners. We might also look at tax revenues. Those tax revenues are driven by the strength of the economy and the soundness of the financial system. If a country is about to implode, it worries a lot of people – including people who hold that government’s bonds.

Is $20 trillion too much debt for the USA? Probably not at the moment. But psychology moves quickly. If we seem unable to restrain our future debts because we spend too much and tax too little that will not make bondholders happy. If our economy grows too slowly or if a recession threatens even worse economic outcomes, that realization will make things scarey. At that point the $20 trillion will seem like a very risky burden.

Ask other countries about how quickly a difficult situation can turn into a crisis. One day you are the darling of the world. The next day people are selling your assets and your currency and you are the basket-case of the world.

We manage debt to be prudent. A modest debt load is normal. A larger amount of debt won’t necessarily undo you but it does raise the risk of some very bad things happening. It is time our US government acted as if they knew this valuable truth.

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