Is the Size of US Debt a Problem?

In the coming days, we will read about the annual Mexican standoff in the US as the Republicans and Democrats jostle over raising the US debt ceiling. It’s a ridiculous game of political brinksmanship that will resolve itself out of necessity. I expect an agreement of some kind at the very last minute.

The issue is that the US has once again run out of money and need to borrow more to fund the basic functions of government such as pay wages and social security payments. Both sides need to agree to lift the previously agreed debt limit or by mid-October they run the risk of defaulting and causing a serious problem.

The debt ceiling has been increased almost 100 times since it was put in place after the war, and not once have the US defaulted. On each occasion, Republicans and Democrats have reached an agreement and raised the debt limit, usually at the last minute, and everything continues on.

But it raises a far bigger question long-term. Just how long can the US continue to fund huge budget deficits and borrow trillions of dollars before it becomes a problem?

At the start of the GFC in 2007, the US National debt was about $9 trillion. The US then embarked on massive spending, funded by debt, to deal with the once in a generation financial calamity. By 2009, the US annual budget deficit was up to $1.5 trillion on the back of only $2 trillion in revenue but spending of $3.5 trillion.

The idea of using deficits in a time of crisis is ok. Why take the full hit in one year when you can borrow now and spread the pain over 10 or 20 years. At the time of the GFC it made sense and likely averted a global depression. Even in times of recession and economic downturns it makes sense.

Unfortunately, we all know that’s never how it works in practice. Once a government starts spending, they rarely know how to reign it back in. Well intended budget deficits, designed to smooth out a serious downturn, become structurally entrenched in the system. People across the world expect their governments to borrow rather than have to go through tough economic times.

Fast forward to 2021 and US Federal Govt has revenue of $4 trillion and spends $7 trillion annually. US national debt is now approaching $30 trillion. The debt will be much higher in the years ahead.

This is not sustainable.

We are not even close to the US bringing their budget deficits under control let alone balancing their budget, and light years away from repaying it. Modern money theory says the US can borrow and print more money to inflate their economy to the point that debt becomes comparatively smaller and more manageable. Great in theory but there are always unintended consequences.

The main reason the US can take on so much debt is because interest rates are basically 0%. If interest rates go up it’s a different story. But even then, debt in the form of govt bonds is typically 10 years to maturity so it will still take time to impact the costs of borrowing for much of their debt.

It might not matter for many years, but it will one day. It is a path whereby the US loses optionality. If anything goes wrong, they are not in a position of strength to choose their path for growth. They are reactive and need to enact measures to get through. That is not prosperity. It is policy failure.



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