The US debt has climbed steadily for decades, and there's no pleasant way to clear it up.
In general, the US government depends on tax revenue to fund its operating expenses. If the government needs more money than current taxes will generate, one of the tools at its disposal is to borrow money, by issuing debt securities or bonds. According to US Federal Debt, a website which monitors the US government debt, as of 23 February, 2017, the US debt stood at $19,935,316,186,835.78. With a GDP of just over $18 trillion, this means that the US government debt now exceeds GDP.
Annually, the difference between what the US government earns and what it spends is tremendous, meaning the government operates on a deficit. According to the US Congressional Budget Office, US government outlays for 2016 were $3.9 trillion, while revenues were only $3.3 trillion, which resulted in a deficit of $590 billion.
The terms budget deficient (or fiscal deficit) and outstanding federal debt (or national public debt) are often used interchangeably. However, while these terms are indeed related, they are not synonymous. The budget deficit is the shortfall, the difference between what the government receives, in taxes, and what it spends in providing services to the country. To make up this shortfall, the US government issues treasury bills, treasury notes and treasury bonds. US government bonds are issued with a face value, say $1,000, which it will pay in 10 years, during which time, the bond pays a periodic interest payment. The bonds go on public auction and purchasers bid on them. The price of a US bond on the open market fluctuates based on the supply of bonds, the interest rate paid by the bond, as well as expectations of changes in supply and interest rates. The accumulation of these debt instruments equals the US public debt.
Congress sets what is known as the debt ceiling, a limit, which determines the maximum amount of debt the federal government is allowed to incur.
It is normal for governments to carry some debt. Particularly during a recession, many economists believe the government may need to increase government spending in order to stimulate the economy, while not raising taxes, which would slow the economy down. All of the world’s top four economies US, China, Japan, and Germany carry large debt to GDP ratios.
Trading Economics reports that China’s government debt is only 43.9% of GDP. China is a special case, as the debt owned by China ‘state-owned company is listed as corporate debt, although ultimately the government is responsible for the money. The Financial Times reports that when corporate debt is considered, China’s total debt equals 237% of GDP. CNBC puts the total at between 240-270% of GDP. Japan’s debt to GDP ratio is 220.20%, and Germany’s is 71% of GDP.
US foreign debt is an oft written about topic, but foreign debt is actually just a small piece of the puzzle. According to Amadeo, about two thirds of US debt is held by domestic investors, social security, military retirement plans, government agencies, corporations and individual investors. The rest, about one third, is held by foreign countries and foreign investors. Amadeo reports that the amount of US government debt held by foreign entities equals $14.1 trillion. She goes on to explain that the largest foreign holder of US debt is Japan, which owns 1.31 trillion. China, the second largest holder, owns $1.115 trillion.
Some economists argue that if the US debt were to become too high, creditors would no longer wish to loan the US government money. This basic macroeconomic logic can be illustrated by taking Jamaica as an example. Jamaica has a debt to GDP ratio of 128.4%. Consequently, Moody’s rates Jamaica government bonds at Caa3. Not surprisingly, the Jamaica Observer reports that the secondary market for Jamaica government bonds was nearly absent as investors avoided them. Bloomberg reports that US government bonds, in spite of relatively high debt to GDP ratios, are the most actively traded government bonds in the world, with $500 billion traded every day.
The Federal Reserve will intentionally increase or decrease the interest rate in an attempt to regulate the US economy. In December, 2016, the US Fed increased the interest rate by .25% suggesting that the Fed’s outlook for the US economy was positive and that raising the interest rate, taking some cash out of circulation, would help slow economic growth and inflation to manageable levels.
Reuters Business News explains that a US Fed rate hike usually results in an overall increase in the volume of trade. This happens because investors want to sell off their old bonds, which pay lower rates of interest, and obtain the new bonds, which pay higher interest rates. Having new bonds issued which pay a higher rate of interest will cause the old bonds to lose value.
The question which most people ask when looking at the US debt is how much is too much. The answer to this question is not simple. One consideration is that the US government is not the only issuer of bonds in the US economy. Corporations also issue bonds, and this is an important source of financing for US businesses. One of the dangers of a government issuing too many bonds is that they will begin to compete with corporate bonds in the marketplace and may make it more difficult for corporations to obtain financing.
On January 13, 2017 CNBC reported that US corporations had already issued a record $88.6 billion in high-grade bonds since trading began on January 2. This would suggest that the US government has not issued enough debt as to negatively impact the ability of corporations to raise money on open markets.
According to an NPR report, governments can comfortably carry a certain amount of debt forward, from one year to the next, because of GDP growth. If GDP is growing at a rate greater than the increase in federal debt, then the debt as a percentage of GDP decreases. Furthermore, the greater the GDP growth rate, the more additional debt a country can take on. If this is not the case, and the debt is growing faster than GDP, the government can take steps to decrease the debt.
According to Investopedia, the federal government has five tools at its disposal to reduce debt: monetization, restructuring, defaulting, increased taxation, or reduced spending.
Monetization – The Economist’s View, an online economics resource, explains government debt monetization this way: when the government needs cash, the Treasury Department issues a bond which is sold on the open market. The government then collects the money and uses it for its expenses. Simultaneously, the Fed prints money and buys the note back from the public. This reduces government debt which is in public or possibly foreign hands. However, the disadvantage of this method is that it increases the money supply and leads to price inflation.
Restructuring or defaulting – Both of these would have similar negative side-effects. For investors, Treasury bonds (T-bonds), bills, and notes are assumed to be the safest fixed income investment (Van Bergen n.d.). The reason why treasury debt is considered a safe bet is because it is backed by the full faith and credit of the US government. In theory, to pay off any debt, the US government could simply print money or raise taxes. To date, the US federal government has never defaulted on a bond (Carney 2011). As a result, the US government enjoys a high credit rating.
According to The Washington Post, the US government had the best credit rating, an AAA credit rating, across all credit rating agencies for over 70 years. In 2011, however, The Post reported that the S&P had downgraded the US government to AA+, the second highest rating.
Having a high rating means that the US government can borrow essentially any time it wishes and at a favorable interest rate. To put this term “favorable interest rate” in perspective, Trading Economics reports that the Venezuela government debt has a credit rating of CCC, which is quite low. Venezuela’s inflation rate reached around 800% in 2016, and government bonds are forced to pay higher interest rates. The US government 10 year bonds, according to Bloomberg, are paying 2.25% coupon rate. In 2016, the Venezuela government 10-year bond paid a coupon rate of 23.70%. If the US government were to restructure or default on a loan, it would lose its good credit rating and have to pay higher interest rates. Therefore, defaulting or restructuring are not pleasant options for cleaning up debt.
Increased taxation or reduced spending – Opponents of increasing income taxes claim that if taxes which are too high serve as a disincentive for citizens to work. And while this is true in theory, one may look at Norway which has an income tax in excess of 46% and yet has one of the highest worker productivities in the world. The US, by contrast only has an income tax rate of 39% which suggests the US has room to increase taxes before worker productivity is reduced. In fact, Finland has one of the highest income taxes in the world at 61.96%, while maintaining reasonable rates of worker productivity. Therefore, the threat of disincentives to work seems unfounded, but other concerns exist. While these methods may be effective in reducing debt, they would be unpopular among the citizenry. This would result in cuts to government services. Additionally, both of these methods would have a negative impact on the economy, as there would be less cash in circulation and consumers would have less money to spend on goods and services. This would cause the economy to contract and unemployment to increase.
As there is no pleasant way to clear up government debt, with the exception of a few years during the Clinton administration, the US debt has increased steadily for decades.