What’s the debt crisis? Just this: The US Treasury may run out of cash by fall. In that case, it won’t be able to pay interest on its loans and will have to default. For the world’s second richest nation (next to China) to admit that it’s broke has, um, interesting implications.
But thank God for the tireless guardians of the public trust. Kevin McCarthy, the moderate California Republican who sold his soul to the neo-Tea Party in exchange for the Speakership of the United States House of Representatives, says the nation simply must observe Congress’s $31.4 trillion limit on the public debt. “If you had a child and you gave them a credit card, and they kept hitting the limit—you wouldn't just keep increasing it."
Actually, you might. The amount that you can comfortably borrow depends on your income. As you become richer, you can take on more debt without flirting with disaster. And so it is with the nation: GDP, the nation’s income, usually rises. We should limit the public debt not in dollars but as a share of GDP. In fact, a bipartisan group of Congressmen has just proposed this.
For three decades, the public debt when measured in
dollars has been rising more and more rapidly, as Figure 1 shows below. But
this substantially reflects inflation rather than real cost. As the government
prints more dollars, the debt naturally claims more of them, because more are
circulating. But the dollars are cheap to print, so they do not represent a
true cost in the sense that we can pay it only by doing without something else.
Figure 2 tells us more about the true cost. It shows
the share of annual GDP that the debt would claim. (GDP is gross domestic product, the market value of what we produce each year. It measures the size of the economy.) For example, if the share is 20%, then paying
off the debt in a year would force us to tighten our belts by a fifth for a year.
You can see that the debt share did not rise steadily
until the financial crisis of 2009, when the government borrowed heavily to
spend its way around an economic collapse. The debt share rose sharply in the response to
the pandemic in 2020 but then actually fell. In other words, the “looming debt
crisis” wildly descried by TV newscasts is a mirage. It occurs only because Congress was so foolish
as to express the debt limit in dollars, a meaningless measure.
Figure 1: Debt soars in dollars...
Data source: US Treasury
Figure 2: ...but not in GDP share
Data source: US Treasury
And we’ve been here before, as Figure 3 illustrates. The Treasury almost ran out of cash late in 2021 and again just before New Year’s. But we survived, and we never heard about it on the six o’clock news. True, the decline in cash balances looks precipitous in Figure 3, but look again. The Treasury had beefed up its balances for pandemic spending. Then it drew them down rapidly over 2020. If we ignore that event, the trend in balances after 2020 will look like the one before and even compare favorably to it.
In short, today’s crisis is due to Congress’s definition of the debt limit and to its delay in deciding the main question: Do we want a bigger government or a smaller one? I can understand the delay. But meanwhile, the Treasury is running out of band-aids, such as suspending payments into the savings plans of government workers.
Figure 3: Treasury operating cash
Source: Reuters
Markets notice. Figure 4 shows the interest rates on
Treasury bonds coming due on the date in the horizontal axis. For example, for a bond that matures in September,
the interest rate is almost 4.6%. People buy bonds (i.e., make loans) to
collect interest, and if they think that the bond might not pay in the end,
they will demand a higher interest rate in the meantime as compensation. As Figure 4 shows, interest rates for bonds coming
due after September rise steadily with each passing month. Maybe investors
think that there’s a growing chance that the Treasury will run out of cash
after September and thus will have to default.
Figure 4: Interest rates on Treasury loans that will
soon come due
Source: Reuters
Figure 5 shows a starker measure of the default risk. This is basically the cost of insurance against the prospect of default in the next five years. Insurers demand higher premiums if they think that they will lose money because the risk will actually occur. Well, the default premiums have been rising since early 2021 and are now soaring.
Figure 5: Credit swap against default
Source: Reuters
Yet we may be over-reacting.
I don’t mean to make light of the debt. It has been
120% of annual GDP for several years, higher than at any time since 1966 at
least. President Lyndon Johnson was excoriated for splurging on the Vietnam War
and the War on Poverty simultaneously in the 1960s, but today’s debt share is
triple his. See Figure 2.
Moreover, we owe more of the debt to foreigners than
Johnson did. We no longer just pay
ourselves. We especially pay
Japan, China, and the United Kingdom, which account for more than a third of
the Treasury securities held by foreigners.
Foreign holdings totaled $7.3 trillion in November, or more than a
fourth of the debt limit. For comparison,
the US produces about $20 trillion of goods and services each year. (Time out
here: A Treasury security is just a loan to the government. Uncle Sam pays
interest on bonds, notes, and bills—long-run, medium-run, and short-run loans.)
Most of these dollars will eventually wing back to the US, since they can’t be
spent elsewhere. (Not all of them. A few
countries use the dollar as their own currency, so dollars paid to them can be
re-spent within their borders.) But meanwhile, we lose control of when those
dollars will be spent. If they are spent
at the wrong moment, they may push up our prices.
Mad max
Even so, we should ask not only what maximum to
impose on the debt share but what minimum to observe. It’s not obviously
zero. You should borrow to pay for college, since it will increase your future
income. And the government should borrow when this will raise our future
standard of living. For example, national defense protects us—protection that
the private sector will not provide, because it cannot force beneficiaries to
pay. The same principle holds for clean air.
For such essentials, which will pay off later, the
government should borrow rather than tax today. After all, future taxpayers
will be the ones to benefit, so they should settle the loans.
Time for boring arithmetic. Feel free skip over it.
Denote as GI the amount that the government
spends on valuable goods that the market won’t provide, like national defense
and environmental quality. Denote the interest rate as r. By borrowing
to invest GI, the government incurs a debt of r*GI per year. For
example, if GI is $1 million and r is .1 or 10%, the annual debt
is $100,000 over the life of the loan, probably 10 to 30 years.
The annual public debt share of GDP is (r*GI)/GDP.
For example, if GDP is $10 million, then
in our example the debt share is $100,000 / $10 million = .01, or 1%.
For simplicity, assume that when the government
extinguishes one loan, it takes on another, proportional to the economy, so
that the debt share of GDP is constant over time.
What federal spending is beneficial? I’m not sure that
I want to answer that question. But, for heroic simplicity, suppose that the
government spends either to grow the economy or to redistribute from the rich
to the poor. The main programs for
redistribution may be Social Security ($1.4 trillion in fiscal 2021), Medicare
($709 billion), and Medicaid ($521 billion). These totaled $2.4 trillion, or a
third of all federal spending. All other federal spending came to $4.9
trillion. Suppose that we treat this spending as beneficial. (I know, I know.) The interest rate on long-term Treasury bonds
in 2022 was 2%. The implied minimum debt share is roughly .02*4.9/20
= .005, or one-half of one percent.
Clearly, this figure isn’t much good for anything other than bar
talk. Not all spending that doesn’t redistribute is good, and not all spending
that redistributes is bad. The Pentagon
wastes money, and Medicaid may spur growth by improving health. Redistributing
to the poor may also stabilize society. But the point is this: Even from a
conservative point of view, observing a minimum debt share need not sock us
hard in the wallet.
What should be the maximum debt share of GDP? This, I think, is the amount that absorbs all
private savings, so that nothing remains to finance private investment, which
surely boosts GDP and consumption over time. Then the limiting debt share would
be the share of personal and corporate savings in GDP. After all, households and firms lend their
savings to companies building factories and to stone-broke youths (I remember
those years) going to college.
More boring arithmetic. From 2010 through 2019, the personal
savings rate averaged 7.3% of personal after-tax income. Profits in fiscal 2022
were $11.7 trillion (wow!). The federal profits tax was 21%, so after-tax
profits were $9.3 trillion (still a wow). The implied maximum debt share of GDP is about
54%. This is less than half the actual
debt share.
Granted, I cobbled together my estimates with bubble gum and
kite string. You shouldn’t take them to
the bank. But the moral, I think, is clear: Sooner or later, and preferably the
former, we should pay down a healthy chunk of the debt. It is high not because we need so much debt but
because we procrastinate in deciding how much, over the long run, we really
want to borrow. –Leon Taylor,
Baltimore, tayloralmaty@gmail.com
References
Jason Lange. U.S. lawmakers preparing plan to avert debt-ceiling crisis. January 22, 2023. U.S. lawmakers preparing plan to avert debt-ceiling crisis | Reuters
Reuters. Cash balance. Cash
balance.png (1016×723) (thomsonreuters.com)
Reuters. Graph of US
credit swap against default. https://fingfx.thomsonreuters.com/gfx/mkt/myvmogqmovr/US%20five-year%20single%20name%20credit%20default%20swap.png
Reuters.
Treasury bill curve. https://www.reuters.com/graphics/USA-CONGRESS/DEBT/lbvggogmavq/chart_eikon.jpg
St. Louis
Federal Reserve Bank. Federal Debt: Total Public
Debt as Percent of Gross Domestic Product (GFDEGDQ188S) | FRED | St. Louis Fed
(stlouisfed.org)
United States Office of Management
and Budget. Budget of the United States
Government for fiscal year 2022. Budget
of the United States Government | GovInfo
United States Treasury. Debt to the penny. Debt
to the Penny | U.S. Treasury Fiscal Data
United States Treasury. Daily Treasury long-term rates. Resource
Center | U.S. Department of the Treasury
