Will Our Debt Doom America?

on
Categories: Blog, Safety,

The U.S. national debt, at the time of the writing of this article, is at more than $22.627 trillion. It is at a record high and numerous people, including some economists, are expressing concern. What’s worse is that the current debt-to-GDP ratio is at 105.21%, which means the country’s debt is 5% higher than what it produces. 

Though this fact is concerning for numerous people, is there really something to be concerned about? Will our huge debt doom America?  In this article, we’ll break down this issue to see if this is something we should be worried about.

Understanding the Debt of America

Before we get into the discussion of answering the question of whether our nation’s debt will doom the country, let’s first discuss the debt of America in more detail to give us an understanding of what it really is and how it impacts the country.

The U.S. needs money to spend on its programs and projects, but since the country has a lot of them, they also need a huge amount of money to support all of it. The federal government generates its income from collecting taxes and these include corporate, excise, and individual. But the amount of income it generates is not enough for all of its programs, resulting in what we call a budget deficit. To cover the deficit, the government has three options, to cut spending, raise taxes, or borrow money. The first two options are not popular options since it means governments will have to scale back on several of the promises they made to the people or they’ll have to add burden to the people in the form of more taxes. So borrowing is the best option in this scenario. 

To cover the deficit, the Treasury Department issues bonds, notes, and bills that they use to borrow money from investors. Corporations and financial institutions (both foreign and domestic), as well as other governments from around the world, can purchase the securities that the Treasury sells. These securities act as an agreement that the federal government will pay back the money they owe with interest after a specific time period. This is how America accumulates debt. The national debt is basically just the measurement of how much money the federal government owes its creditors. As the government spends more money on its programs and projects, the national debt will just continue to rise.

National Debt and Gross Domestic Product

Debt-to-GDP ratio is a common term that you would usually hear in the news when a discussion about the country’s debt is brought up.  GDP is the measure of the goods and services that a country produces in a given year. Some economists and media outlets usually compare the national debt of the country to its GDP and its not really wrong to do so since there’s a correlation. But comparing these two doesn’t really provide a good picture since the country’s debt is not paid back using the country’s GDP. Tax revenues are what pays for the country’s national debt. This is why raising or cutting taxes is always one of the main talking points of Congress when they’re discussing the national budget.

The Two Categories of Debt

The U.S. debt is divided into two categories: intragovernmental holdings and public debt. The intragovernmental holdings are the portion of the debt that is owned by other federal agencies, while the public debt is the one held by everyone else, including foreign corporations and governments.

As of August 2019, the public debt is at $16.6 trillion, which is about 73.9% of the country’s $22.46 trillion debt during the same period.  The foreign holdings were at $6.64 trillion in July 2019, which is a $97 billion increase compared to the month of June. Japan is the number one holder of U.S. debt with $1.13 trillion and China as the close second with $1.11 trillion.

The rest of the debt, about $5.9 trillion or 26.1% of the country’s national debt is held by other federal agencies. This would include the Social Security Trust Fund, which accounts for most of the U.S. debt holdings of federal agencies, the Military Retirement Funds, Medicare, and Federal Retirement Funds to name a few.

How The National Debt Affects the Country

Now that we have a better understanding of the U.S. national debt, it’s time to discuss how it affects the country. This huge debt is concerning since $22 trillion is an astronomical number. But this debt, though a record-high, is not really new for the country. It was during Barack Obama’s term when the U.S. debt reached a high of $20 trillion, but that was also the period when the Great Recession hit the country.

The huge debt accumulated during the great recession was deemed as necessary since it jump-started the economy. In the short-term, deficit spending is beneficial to the economy since it will drive growth. As the U.S. spends money on health care, building and road construction, and defense equipment, just to name a few, it hires private companies and contractors to provide these services. This means money is infused and circulated in the country. As the number of projects that governments have increased, more money is infused into the country. To keep up with this demand, companies start to hire new employees, thus providing jobs as well. With the federal government ramping up on projects and programs, they’ll also start to hire new employees and provide more available jobs in the country.

People will have money to spend on goods and services, which is again good for the country’s economic growth. Basically, as the government spends money, the country’s GDP will also increase since there will be more goods and services produced. Government spending is also responsible for a big chunk of the country’s GDP, so increasing spending affects that as well.

However, the long-term effects of huge debt are not as rosy.  An article from “The Balance” compared a growing federal debt like “driving with the emergency brake on.” This means that the economy is growing, but the growth is slow since it is also hampering it. Having a huge debt increases the risk of the country defaulting on its obligations, which could have lenders asking for higher interest rate payments on the money they lent. Though this has yet to happen, there is a real concern about this coming from many economists and experts. Another long-term effect that a huge national debt has is that the demand for U.S. treasuries could diminish meaning securing money to run the country could dry up.

This is actually happening as the demand for U.S. debt by foreign investors has decreased. A report from The Fiscal Times in November 2018 showed a chart that revealed the demand for the 30-year U.S. Treasury bonds is at its lowest since 2009. Another report from The Fiscal Times in February 2019 that foreign ownership of U.S. debt continued to decline, reaching below 40%.

The issue here is that the yields (interest rates) could increase since the demand for treasury bonds are decreasing. Though high-interest rates would attract more lenders, it also means the country will have to pay more once the bond matures. This will slow down the economy since the country will have to allot more money to interest payments. Fortunately, the void left by foreign investors was filled up by domestic demand. The country’s households increased its exposure to U.S. bonds from $1.4 trillion in 2017 to $2.3 trillion in 2018. This is keeping interest rates lower.

But one thing that domestic demand for bonds can’t save is the value of the U.S. dollar. When foreign investors want to buy U.S. bonds at an auction, they’ll need to buy U.S. dollars in order to do so. As foreign demand for U.S. bonds increases, the value of the dollar will also increase relative to the currency of the foreigner buying the bond. So, if foreign investors start dumping U.S. bonds, they’ll also start dumping the dollar, thus providing downward pressure on the currency. This also means the country will have to pay back foreigners holding the security at a currency that has less value. A lower dollar will also affect the country’s imports since this means they’ll buy goods abroad at a higher price because of the dollar’s lower value.

.

Can the Huge U.S. Debt Be A Problem For Us?

After learning all of the information that we have discussed up to now, it is now time to discuss if this huge debt of America will doom us all. In order to properly see if this $22 trillion dollar debt will be the country’s downfall, we’ll have to look at it in two aspects: Why it doesn’t matter and why it matters.

Why it Doesn’t Matter

Though the country has reached a record-high debt and the debt-to-GDP ratio is at 105%, not all economists, experts, and politicians are concerned about it. One of the reasons they’re not concerned is the fact that more than a quarter of the country’s debt is held by the federal government themselves. As discussed earlier, 26.1% of the U.S. national debt is held by the different federal agencies, which technically means the government owes money to itself.

But even the rest of the debt that the country owes is still not enough to cause concern since the U.S. government actually has the capacity to pay, not the entire debt, but the interest on them. The U.S debt that it sells to investors has a maturity date and it doesn’t need to pay off its entire debt until that maturity date. The country only needs to pay the interest rate, which is done twice a year.  A September 2019 report from USA Today stated that the interest rate payments of the country are only 9.8% of tax revenues. This means that the U.S. has the money to pay its debtors their interest rates twice a year. This figure is lower than during the 80s and 90s when interest payment was at 18.4% at its peak.

It is also important to note that the huge debt of the country is a bad indicator to determine bad fiscal policy.  What we need to look at is if the government is spending the money properly. As our government increases programs and projects, spending increases as well. So a high debt is not necessarily bad, especially if the money is used to generate opportunities for the population. Take a look at a country like Venezuela who has a debt that is only 23% of its GDP in 2017. But the country’s economy has been in chaos for several years already, so their debt is not an indication that they have a good fiscal policy or that they’re not being a burden to the population.

Why Does it Matter?

Though the huge debt might not be concerning if you look at it from a certain perspective, it doesn’t mean that we should just ignore it or let it continue. This huge debt will still have an impact on our economy and we’ve already tackled the effects it could have like the decreasing demand for our securities from foreign investors, which in turn put downward pressure on our currency.

Yes, domestic demand is filling the void left by foreign investors. But with the country already showing some cracks on its economy and a looming recession on the horizon, the country would need to rely on investors and creditors, especially foreign creditors, to help keep its economy afloat. And with foreign lenders already starting to shed their exposure to U.S. debt, relying on foreign investment could be an issue should the country enter into a recession.

Speaking of recession, having a huge debt will limit the government’s capacity to respond to another financial crisis. When the Great Recession hit in 2007, one of the country’s responses was to increase spending to try and jumpstart the economy. This is why our debt ballooned to $20 trillion during the Obama administration, as they ramped up spending as a response to the crisis. With our country already dealing with massive debt, increasing spending by borrowing more money is already out of the picture should we experience another recession.

Interest payments are actually a concern as well, especially if the interest rates will go up. Though the Federal Reserve Bank recently cut interest rates, the interest rates of bonds can still go up. If foreign investors continue to shed their exposure to U.S. debt and demand continue to soften, the interest rate will still continue to rise due to the rule of supply and demand. Another thing to worry about is that the net interest cost of the country is still projected to increase to $921 billion by 2029. This means that the country could soon find itself spending more money on net interest costs than on other important aspects like medicare.

Another cause for concern is paying back all of the country’s commitments. The $22 trillion debt actually just represents the country’s formal commitment to pay back its creditors. There are also other future commitments that the country has that are not on the books. These other commitments include support for housing, actions taken by the Federal Reserve, deposit insurance, other loan guarantees, and government trust funds. The estimated total commitment of the country is actually at $70 trillion, which is more than 3 times the national debt. Should the U.S. need to start paying back on these commitments, the huge burden will likely fall on the shoulders of the citizens. The government will likely have to raise taxes to get more revenue to pay for all of these commitments.

The debt situation of the private sector is not doing any better as well since the non-financial corporate debt has already reached 74% of GDP. This is projected to increase, especially after the Fed has cut interest rates. Companies, even those with poor credit, will continue to borrow money to finance their expenditures. The problem here is that earnings outlook in the private sector appears bleak, which means numerous companies might not have the capacity to pay back their debt and increase the likelihood of default.  Business and investment sentiment could also decrease due to the high debt burden.

Looking at the things that we have discussed here, the huge debt that the U.S. has will not doom the country in the short-term. The strong economy and fiscal policies in place will ensure that the U.S. won’t succumb to the massive debt and cause the entire economy to collapse. However, there are still some causes for concern, especially if we look at the long-term effects of a huge debt.

In the short-term, the talk of a looming recession in the next 2 years is the main concern with regards to the impact of our country’s huge debt. It decreases our options and financial tools to fight back the crisis, which makes us even more vulnerable. As for the long-term implications, one of the main issues is if the country’s commitments start taking effect, the financial burden it will cause to the population will be massive. The projected rise in interest rates and net interest costs also means that the bill for this debt will be expensive in the future.

Conclusion

America’s huge debt, in theory, should not cause the country to collapse in the short-term. However, this doesn’t mean that we shouldn’t be concerned since the country can’t keep up this kind of high debt burden forever.

Plans and policies should soon be implemented to start lowering the country’s massive debt and avoid having to deal with harsher consequences in the future.  Obviously, the changes that would need to be made now will not be popular with voters as it will mean cuts in government spending will have to be made or taxes will need to be raised, neither of which is good for politicians when they seek re-election.  For now, we’re simply kicking the problem down the road.

If you enjoyed this article, please click the like button and share it on social media. Please feel free to provide tips, suggestions, or added information in the comment section below.

As always, stay safe out there.

0 0 vote
Article Rating