Is the National Debt too High?
I can’t count the number of times that, during a discussion about the economy with a client or a friend, the question of our national debt has come up. To a person, they’re worried about how far in debt our country is to other countries, and how significant that debt is as a percentage of our Gross Domestic Product (GDP).
It’s not surprising that it happens so frequently. There’s hardly a day that goes by when some news outlet isn’t telling us about the impending economic doom that awaits our country due to the size of our debt. They make compelling arguments as to why we should be terrified about our economic future, and/or the long-term viability of our currency, but should we?
That’s the question we’re going to tackle today.
Is our national debt so high that we’re riding the razor’s edge of financial solvency? We’ll present the facts and let you decide.
US National Debt and GDP
Figure 1 is our national debt as a percentage of GDP from the first quarter of 1966 through the first quarter of 2020. The data are only updated quarterly.
Figure 1 | Source: YCharts
As you can see, our debt level is high, and at the end of the first quarter of 2020, it had increased to 106.8% of our GDP.
Past GDP and National Debt Numbers
Those debt levels are unnerving, to say the least. A closer look, though, tells us that debt levels don’t always go up and that what we are experiencing may not be the case in the next several years. Let’s look at the last 10–12 years in Figure 2 to see if that changes our perspective.
Figure 2 | Source: YCharts
Notice that in early 2007, our debt to GDP was a fraction of what it is today. The financial crisis of October ’07 – March ’09 triggered a massive increase in the total debt. That increase didn’t stop until the last quarter of 2016 when the last vestiges of the quantitative easing programs brought on by the financial crisis ended. It was at that point that the Federal Reserve began normalizing policy, removing some of the excess cash from the financial system by selling back the bonds they’d purchased from the banks during/after the crisis. When that got underway, our debt levels began to flatten and even drop slightly.
Recent National Debt Increases
Figure 3 shows just that. In fact, from the end of 2016 to the first quarter of this year, the debt has only increased by 1.5%. Much of that increase is likely attributable to the stimulus money used to help ward off the potential economic damage anticipated from the Coronavirus’s shutdown of broad swaths of the economy. The second quarter’s numbers probably won’t look any better, and some estimate that we could see the debt jump to 110% of GDP or higher when released. I tell you that so you’re not surprised next month.
Figure 3 | Source: YCharts
National Debt as a Percentage of GDP Internationally
We most definitely have an issue with the size of our national debt; there’s no question. For further perspective, let’s compare our national debt as a percentage of GPD to counterparts around the globe in Figure 4.
We’re number 11 on this list, and we’re far better off than Japan at 238% of GDP. Did you notice that China isn’t on this list? Well, they should be, and they would be at the top. Here’s why they aren’t. China’s “official” government debt to GDP is currently at 50.5%, as reported in December of 2018. Those are the most recent “official” numbers we can find.
National Debt in China
What you have to keep in mind are the facts that;
- China has a very fast and loose relationship with the truth
- Nearly 50% of the corporations in China are SOE’s (State Owned Enterprises).
According to the World Economic Forum, China has 109 companies on the Fortune Global 500 list, but only 15% are privately owned. The rest are SOEs or State Operated Enterprises. These SOEs have considerable latitude to borrow money that is ultimately the responsibility of the Chinese government.
A recently released report from the Institute for International Finance (IIF) says China’s debt-to-GDP ratio for the 1st quarter of 2020 shot up to 317% from an estimated 300% in the 4th quarter of 2019. Yes, the country that everyone is afraid will buy America has a debt to GDP ratio of 317%. However, because the SOE’s debts don’t get reported as official government debt, they look excellent on paper. Thankfully, there are people out there like the IIF doing the hard work of discovering the truth about China’s finances.
The Debt to GDP Ratios Don’t Always Increase
Remember, this is not to excuse our borrowing habits in the US, but to get a better perspective about our actual debt situation by looking at the situations of other large economies around the world.
Next, let’s remember that our debt to GDP ratio does not always increase. There have been times in our not too distant past that our debt to GDP ratio has declined precipitously over several years. Figure 5 and Figure 6 below show a couple of examples:
Figure 5 | Source: YCharts
From the first quarter of 1966 to the end of the third quarter in 1981, the US Government debt to GDP ratio declined by 24.14%. That quarter ended at 30.6% of GDP. That’s impressive. After climbing back to 65.31% of GDP by the second quarter of 1995, it dropped by 17.26% by the end of the second quarter of 2001. That’s where it ended at 54.04% of GDP. Again, impressive.
Figure 6 | Source: YCharts
This Isn’t the Worst National Debt to GDP We’ve Seen
It’s also worth keeping in mind that the elevated levels we find ourselves at today are not the worst levels we’ve seen. In fact, during the war effort for WWII, our debt to GDP reached an astonishing 118.9%. So, it has been worse and could be worse.
The question is, can we sustain the debt? Is our spending becoming an ever-larger percent of our GDP? The answer is, surprisingly, no. US Government spending has ranged from a low of 33.4% of GDP to a high of 43.3%. The last reading in 2019 was 37.8% of GDP, down from 38% on the previous reading. As long as our economy keeps growing, those numbers should be kept under control, unless interest rates go back to historical norms quickly.
That’s unlikely to happen though, given the market’s reaction to the fed funds rate hitting 2.5% in the 4th quarter of 2018.
Can We Continue to Service Our National Debt?
So, can we continue to service the debt we have outstanding? That’s the real question that everyone wants answered, even if they don’t know how to ask it. Here again, growth and interest rates are going to play a key role, and are also the reason I don’t believe interest rates are going back to “normal” any time soon.
This next chart shows the effects of interest rates on the amount of money we have to spend to service our debts.
Figure 7 and Figure 8 show us from the beginning of the financial crisis until the fed started raising interest rates in late 2015. Then in earnest in 2016, the amount of money we needed to spend to pay interest on the treasury debt was trending down, despite the expanding debt because the fed funds rate was zero. As they tried to normalize those rates, the cost to service the treasury debt began to increase. Now that the fed funds rate is back to zero, we should see that number start to fall again.
Figure 7 | Source: YCharts
Figure 8 | Source: YCharts
Though it is different in some ways, it’s easier to think about the ability to service the debt when you think about it in terms of consumer debt, the kind of debt citizens have.
Figure 9 shows the increase in total household debt from 1999 to today in blue, and the percentage of household disposable income it takes to service that much more significant chunk of debt today versus 1999 in orange. Notice that debt service as a percentage of disposable income has fallen by 13.37% over the same time that household debt has increased by 215%. Without wage growth (economic growth) and lower interest rates, this would not be possible.
Figure 9 | Source: YCharts
Figure 10 | Source: YCharts
Note on Figure 10 above that, even though total consumer debt has increased from just under $6 trillion in 2000, it took 12.5% of disposable income to service. In 2020, its $14.3 trillion, and it only takes 9.73% of disposable income to service.
The federal debt works essentially the same way. So, even though our debt as a nation has increased by 164.7% since 1966, note Figure 11, as long as we can continue to service it by growing the economy and keeping interest rates low, we may be okay.
Figure 11 | Source: YCharts
So, Do I Need to Worry About the National Debt?
The reality is that our ability to service the debt remains solid. And, for now, the full faith and credit of the US Government and its ability to pay its debts remain in full effect. As long as that remains the case, people will continue to loan us money to finance whatever projects we want to finance. Should that ever change, though, that’s when the trouble will start. If we lose the ability to roll our debt over because we’ve lost the trust of other countries, God help us all. Because then, the great depression will begin to look like a beginner’s course in financial failure. Fortunately, that’s exceptionally unlikely to happen in any of our lifetimes or the lifetimes of our children.
So, don’t add the national debt to the list of things you need to worry about. You can’t fix it by worrying about it, and it’s unlikely to affect your life in any meaningful way. Therefore, the keys to opening the door to a more stable US financial condition are economic growth and continued low-interest rates for the foreseeable future. Let’s hope for both!
Shane Barber, for the Partners and Advisors of Modern Wealth Management
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.