Mark Schniepp: National Debt; How Bad is It?

By Mark Schniepp 
January 2020 

The national debt has continued to be a significant subject of domestic controversy, especially in view of the magnitude of fiscal stimulus undertaken by presidents Bush, Obama and Trump. 

Generally, economists agree that: 

  • Rent control is bad 
  • Tariffs are bad 
  • High minimum wages are bad 
  • Wealth taxes are bad, and 
  • Too much debt is bad 

Actually, everybody knows that too much debt is bad, but does the United States have too much debt now? Many believe that the U.S. debt is growing at an unsustainable rate, and that if debt holders grow pessimistic and stop buying U.S. securities, a debt crisis would ensure, shackling many Americans to a poorer quality of life in the years to come. 

The national debt currently stands at $23.2 trillion (Dec. 31, 2019), and this is the highest level ever. Federal debt held by the public accounts for $17 trillion and this is the more useful debt number because the government has to pay this back to people and corporations and countries that own U.S. treasury bills, notes, and bonds. That’s how it got into debt in the first place, by selling securities to the public. 

The other $6 trillion of the national debt are loans between government departments. One of these is social security which is owed billions by the federal budget for monies received over time to finance government spending. The federal budget has to pay this back as well, especially as the demands on Social Security rise and the department must deliver retirement benefits. 

Since 2017 when Trump entered the White House, the debt has increased by $2.7 trillion. 

During the Obama administration, debt rose $8.2 trillion. During Bush, debt jumped $6.4 trillion, and Clinton: $1.4 trillion. 

What is the Problem with Debt? 

When the federal government borrows money to finance economic expansion, it’s normally accepted by the public because both current and future generations will reap the rewards of this expenditure. In the short run, the economy benefits from deficit spending when it is directed at economic growth and stability. The federal government pays for major infrastructure projects or defense equipment, and contracts with private firms who then hire new employees. Healthcare expenditures do this as well. These new employees then spend their government-subsidized wages on gasoline, groceries, new clothes, and more, and that boosts the economy over time. 

When the federal government incurs debt to increase current consumption such as Medicare, Medicaid, veteran’s benefits, or Social Security payments, only the beneficiaries of these programs will receive direct payments, and often these programs are without widespread support from the public. We often question these expenditures. 

It’s the same issue for households. If you go into debt to make investments that will benefit you and your family in the long run, you feel the increase in household debt is worthwhile. However, if you deficit finance your new boat or a Hummer SUV, some measure of guilt is going to haunt you, along with perhaps your spouse. 

When interest rates rise, there are higher debt payments which can overwhelm the annual federal budget, just as higher mortgage, boat and car loan rates increase your monthly payments and wreak havoc on your household budget. Had you stuck with the 2011 Camry, you’d probably have much lower car payments and less overall stress. 

Higher Interest Rates 

In the long run, debt holders could demand larger interest rate payments to continue carrying U.S. debt, because the risk of being repaid rises with expanding debt, especially as a percentage of Gross Domestic Product. A decline in the demand for U.S. Treasuries would increase interest rates, raising debt payments for the government (and households too), and at the same time, slowing the economy. 

If the demand for U.S. Treasuries was to decline, the value of the dollar would also decline relative to other currencies, and foreign governments like China would be less willing to buy U.S. debt (i.e., bonds). 

The Treasury Department would then have to offer higher yields (interest rates) on newly issued Treasury bills and bonds to attract new investors and maintain the debt levels. This would create more debt due to the higher payback obligation. 

Debt Crisis 

Is a debt crisis coming? Well, is the demand for treasuries declining and yields (interest rates) rising? The answer so far is no. There is sufficient demand for U.S. Treasuries largely because the yield on the 10-and-30- year bonds is so much higher than for government bonds in Japan or Canada, or anywhere in Europe or Australia. In other words, it’s still one of the safest investment instruments in the world and it pays a higher return. 

A crisis is unlikely any time soon. But there is a general notion that the tin can of debt cannot be continually kicked down the road forever. This is especially true when the Social Security Trust fund won’t have sufficient funds to finance the retirement benefits of the baby boom generation that is retiring now at an accelerated rate. 

Congress will ultimately have to raise taxes to generate the revenues needed to finance the budget and pay the Social Security Trust fund back. Either that, or benefits will have to be curtailed, impacting younger boomers who will retire last, and the older Gen Xers who will retire first. 

Do we need to pay closer attention to this now or can we continue to defer serious action towards addressing the national debt? Right now, the net interest expense represents 8.7 percent of total federal expenditures and is less than outlays on Medicare, Medicaid, Defense, and Transportation & Education. It’s rising again, but it’s low compared to the 1980s and 1990s. 

Clearly, debt needs to be paid back, and with tax dollars. Ever rising debt will ultimately push interest rates higher along with debt service payments, diverting the amount of direct tax revenues that could be used on other government services. The public’s quality of life is therefore diminished. The federal government would have to raise taxes to maintain existing service ratios for the public, and higher tax rates would reduce disposable income for households. 

So, at some point in time, we or future generations are facing higher taxes or diminished government services or both. 

Conclusion 

The national debt, when managed correctly, can be used to stimulate economic growth and future prosperity. However, rapidly increasing debt would ultimately raise the interest expense on the debt. And, taxes will need to be raised to finance the debt service or government services will have to be meaningfully reduced. Both results are likely. 

Mark Schniepp is head of the Goleta-based California Economic Forecast, an economic consulting firm that produces commentary and analysis on the U.S. and California economies. The firm specializes in economic forecasts and economic impact studies, and is available to make timely, compelling, informative and entertaining economic presentations to large or small groups.   

Re-posted by permission Jan. 3, 2020. 

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