Do we really NEED to be concerned about the debt?


Do we really NEED to be concerned about the debt?

In short, yes. However, there are many aspects that one needs to look at and in the short-term, maybe not.

The total outstanding debt of the United States federal government stands at just around  16 trillion dollars (that’s 16,000,000,000,000.00) according to the US debt clock . That seems like a lot, and in fact, IT IS. The current debt level exceeds our GDP of 15.09 trillion dollars (according to the World Bank), making the total debt-to-GDP ratio (debt/gdp) 106%. 

How does this stack up? Well, good news, we are not alone- and in fact many countries are in much graver positions. Countries such as the U.K., Belgium, Switzerland, Germany, Japan, Sweden, France, Ireland, and Italy… for a complete list check out wikipedia’s page on external debt

But the question is, do we need to be concerned about the debt? 
My answer is three part. 

First: In short, yes. We cannot forget about the debt, spend recklessly, and hope for things to be a dandy. As the deficit continues, our debt increases. It’s simple. At a certain point, countries will stop buying treasury bills (t-bills) and the treasury will be forced to raise interest rates to a level that will force it to borrow more just to cover interest. 

I would also like to note, the current level of debt given our interest rates are completely, 100% sustainable. The problem we have is with unfunded liabilities such as social security, that will inflate the debt multiple times over. 

Second: In the short run, no. Treasury rates, the yield the government pays for its debt, are 0.70% for a 5-year bond, 0.35% for a 3-year and 2.97% for a 30-year. Compare 10-year bond rates to countries who are in real trouble, Spain (5.69%) and Italy (4.92%), the United States rate (1.79%) is tremendously low. 

What we have here is investment 101: If you can borrow at 0.70% per year and can put that money into an activity that makes more than the yield + inflation, you have just made a profit. In fact, this is largely how banks operate.

What the United States should be talking about is increased stimulus centered around encouraging business growth, investment in infrastructure, and expanding R&D. Since we cannot trust the government to do anything that generates us a sound ROI (return on investment), this stimulus could come in the form of expanded SBA (small business) loans, research grants, and educational grants. Anything that the United States thinks will lead to a ROI greater than the yield on their loans. 

So in the short-run, people should be chanting borrow baby borrow! Expanding the economy reduces our debt-to-GDP ratio and the returns will eventually mitigate any cost of stimulus, making our country even more desirable to invest in. And so the world turns.

But it isn’t so simple as you will find out.

Third: In the long-run we should continue worrying about the debt, eventually either the government needs to bring receipts up through raising tax revenues and reduce spending through cuts or improving efficiency. Now here is a nifty accounting trick, if the government continues spending at current levels (nominal), and doesn’t raise taxes, the debt problem vanishes. 

How so? Well, as the economy heats up and we experience growth, tax revenues automatically rise, stabilizers kick as people become gainfully employed and stop relying on welface services, as the economy grows people make more money and therefore pay more taxes. With all of this, the deficit shrinks, turns into a surplus, and gradually the debt diminishes. The effect is seen even faster as the debt-to-GDP ratio falls quickly as they are inversely related.

Great!… But wait. The problem. How do we get government to stop expanding, or not touch tax rates? Here is the dilemma, once programs are funded, they get vested interests and they never shut down. Once you cut taxes for temporary purposes, the people are upset when you let them “expire” (bush-era tax cuts). This problem becomes incredibly evident when we recap our second answer.

Remember, that in the short-run we can invest and spend our way to an optimal growth path (in the long run reducing our deficit/debt problems.) The immediate result is more money in the economy and growth, coupled with a higher deficit and more debt. The idea is when the economy heats up, the government puts on “the brakes” and cuts these counter-cyclical spending measures. As we just explored, they usually don’t… and BAM Debt-problems.   

Please know, the federal reserve does NOT print money.

Finally: I will write more about this shortly, but one should also keep in mind that the United States is in a unique position currently, being the world reserve currency. We own the dollar, we have a federal reserve that right now is thinking about shoving money into the economy (quantitative easing). The overwhelming majority of our debt is held in dollars, and we own the dollars “machine”, through inflation we could tremendously reduce the burden of debt (of course, with its own fallouts). 

Blog’s twitter: Ideafart
Author’s twitter: DanielSethMcKay

8 thoughts on “Do we really NEED to be concerned about the debt?

  1. Pingback: I Like to Think Our Debt is $4 TRILLION, NOT $16! Math lesson | ideafart

  2. Reply Andrew Sep 27,2012 %I:%M %p

    Most of this seems pretty sound, as far as I know. I’d like to point out a couple issues I had with this post, though.
    1. You mentioned investing in small business. The fact of the matter is that there are a lot of small businesses that aren’t going anywhere. I think that the government should concentrate on small start-ups instead. Right now, rich people can gobble up huge profits by finding and investing in ingenious ideas, but there are more good ideas than money to fund them. The government (federal or more locally) could supply the funds in return for a cut in any profits and not cost the taxpayer a dollar
    2. We do control the reserve currency, but how strong is our hold? If something major were to happen, we could lose our privileged status. How would we recover from that?
    3. The post’s last two pictures seem kind of gratuitous. I don’t see how Barbie has anything to do with the topic, and I don’t understand what the Fed/ Treasury picture is supposed to add to the discussion (even if the secret agent in the background was a nice touch).

  3. Daniel McKay Reply Daniel McKay Sep 27,2012 %I:%M %p

    Thank you for the input Andrew.
    To address your comments:

    1. I completely, 100% agree with you on the start-ups and the current problems you highlight. The government could actually turn a profit by investing in these, and do it on terms mutually beneficial (such as no ownership, no voting shares etc.)

    2. We do face competition as the major reserve currency, namely from the Euro and the Chinese Yuan. I don’t think we are at much risk right now of losing that status (eurozone crisis, China’s ailing economy) although if we were to finance our debt by printing new money we might very well lose our status. The repercussions would be paying a higher interest rate and being more vulnerable to exchange rate fluctuations.

    People flock to the dollar for a few reasons, namely our economic strength, the ability to repay our debt, and the fact we have a nearly impeccable credit history. I hope in the article I didn’t come off as sounding like printing and inflationary fiscal easing to be a policy. It is a backstop if all else fails, and there are serious repercussions.

    3. Very well noted.

  4. Reply Nikos Sep 28,2012 %I:%M %p

    Nice job Danny!
    I believe the main issue for the US government is how to take advantage of the current economic instability and the very low interest rates of T-Bonds. As you mentioned, US can issue bonds with a very low interest rates, however in my opinion the hard part is how to invest the money wisely and even most important and difficult is how to measure the effect of those investments because the last think you want to do is start spending with not having a strategy and a measure to measure the impact of those investments.
    Another issue, is the Municipal bonds and notes. I am not sure if those ones are included in the US debt, I am sure you know better. In contrast to Treasury bonds Munis are not backed by Fed so it is possible those Counties, Cities etc. to declare bankruptcy simply because they might not be able to pay back their Debt and at the same time they do not have the ability to ‘print’ dollars. This is another concern and especially for some states like California where the debt is really high.
    What do you think about it?

  5. Daniel McKay Reply Daniel McKay Sep 28,2012 %I:%M %p

    Municipal bonds and notes are NOT included in the debt, we are talking about just national debt. Lenders give to states and municipalities at their own risk, if they file for bankruptcy they simply will have to pay higher bond rates in the future – the situation is much more dire for them. The real focus on the debt should be for the states, because that is the real issue – states like California you mention. If they default, expect some turbulent times.

    I cover what the government can invest in on an upcoming post (will be on monday). Stay tuned!

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