A few days ago the total U.S. debt surpassed $19 trillion. It’s such a huge amount that for the sake of clarity let’s write it down in numbers: 19,012,827,698,418 (exact amount as of Jan 31st, 2016). Since 2009 the debt has risen by a staggering $8.4 trillion and during the same period inflation has basically been zero. How concerned should you be of this development?
To put things in perspective, the U.S. is the world’s largest economy with a nominal GDP of $18.12 trillion (Dec 31st, 2015) and a population of about 320 million. The debt to GDP ratio is now about 105% and has thus exceeded the psychologically important 100% level. In the EU public debt is considered excessive if it exceeds 60% of GDP.
The reason for the massive growth of public debt since 2009 (+79%) is that the government has been running hefty budget deficits. In 2015 the deficit was $439 billion (2.5% of GDP) and in 2014 it was $483 billion (2.8%). Again, according to the EU a budget deficit is excessive if it’s greater than 3% of GDP.
It’s clear that stimulating the world’s largest economy after a historical recession costs a lot of money. So does maintaining a huge military power. Welfare and healthcare for citizens isn’t cheap either. In many ways it's understandable that the U.S. Government has been spending more than it's been making. And besides, debt is really cheap now so why not take a lot of it for boosting economic growth and improving the well-being of everybody!
The problem is that the U.S. debt is growing at an alarming rate. The Congressional Budget Office forecasts that the public debt will hit $22.6 trillion by 2020 and will rise to $29.3 trillion by 2026. One can only speculate how many painful Washington debt ceiling fights the world has to endure during the next ten years. What’s worse, the U.S. economy will most likely not grow with the same speed. GDP would need to grow by 5% each year to match $29 trillion in 2026 – and that’s more or less wishful thinking.
I suppose most people have the intuition that too much debt is a bad thing. Or that debt can become unsustainable if it grows too fast compared to tax revenues. We have also seen what happens when creditors lose faith in a debtors ability to service its debt. Shortly put, it’s a messy situation nobody wants to end up in. I can’t even imagine what would happen if the rest of the world would lose it’s faith in the U.S. as a debtor.
But what about those academics and politicians who think a lot of debt is in fact a good thing? Those who say we shouldn't be irrationally scared of debt? There are even those who are making the case that America (and Europe) needs more, not less, government debt!
Paul Krugman is probably the most famous proponent of debt driven stimulus. In a recent New York Times Op-Ed titled "Debt Is Good” Krugman writes: “Issuing debt is a way to pay for useful things, and we should do more of that when the price is right. The United States suffers from obvious deficiencies in roads, rails, water systems and more; meanwhile, the federal government can borrow at historically low interest rates. So this is a very good time to be borrowing and investing in the future”.
In another article titled "Nobody Understands Debt” Krugman writes: “Families have to pay back their debt. Governments don’t — all they need to do is ensure that debt grows more slowly than their tax base. The debt from World War II was never repaid; it just became increasingly irrelevant as the U.S. economy grew, and with it the income subject to taxation.”
The crucial point in Krugman’s argumentation is the expected growth in tax revenues. Well, what happens if that assumption doesn't hold? What if we can't ensure that debt grows more slowly than the tax base? It's not an unrealistic scenario, because all it takes is that the economy doesn’t grow as fast as we hope. And even if it did, there’s no guarantee that politicians in Washington are able to decide on sufficient taxes.
Personally I believe there are times when fiscal stimulus is needed, but it can’t go on forever and ever. You simply can't let indebtedness get out of hand. Now it seems like the U.S. (and several other developed countries) are in a debt spiral with no deleveraging in sight.
A report by McKinsey & Company from 2015 showed that debt is unsustainably high in many countries. Since 2007 global government debt has in fact grown by $25 trillion. Furthermore, it will continue to rise in many countries, given current economic fundamentals. In other words, the financial crisis, which was caused by a global credit bubble, did not result in a reduction of indebtedness, or deleveraging. Instead all major economies have today higher levels of debt to GDP than they had in 2007.
The McKinsey report also concludes that for many of the highly indebted countries deleveraging would require implausibly large increases in GDP growth or extremely deep fiscal adjustments. Alternatively new approaches are needed, such as extensive asset sales or one-time taxes on wealth. You could add strong inflation to the list of new approaches, but inflation seems to be difficult to fire up – and once it starts rolling, it can be challenging to control.
Based on recent GDP and labor market figures, it looks like the U.S. economy received the boost it needed for getting the growth started. The world still has faith in the U.S. and the same goes for credit rating agencies like Moody's and Standard & Poor's. Now it's time to shift focus to the budget deficit and take proper measures. The ever-growing debt mountain must be treated with realism and resolution.