The US National Debt: A Tipping Point?

May 23rd, 2020 | By | Category: Featured Issues, Politics & Current Events

The United States is embarking upon an experiment in borrowing without precedent, as the government and corporations take on trillions of dollars of debt to offset the economic damage from the COVID-19 pandemic.  Several specifics:

  • The federal government is on its way this year to spending nearly $4 trillion more than it collects in revenue—a budget deficit roughly twice as large relative to the economy as in any year since 1945.
  • Business borrowing also is setting records. Giant corporations such as ExxonMobil and Walgreens, which “binged on debt over the past decade,” now are exhausting their credit lines and tapping bondholders for even more cash.
  • To support such borrowing, the Federal Reserve has dropped interest rates to zero and added more than $2 trillion of loans to its portfolio in the past six weeks—as much as in the four years following the Great Recession.

 

As David Lynch of the Washington Post suggests, “The reliance on so much debt also will leave scars after the pandemic passes, economists say, making it difficult for policymakers to withdraw support and leaving the economy more vulnerable than before this crisis began.”

“We should be very worried,” said Atif Mian, an economics professor at Princeton University who has written widely on the subject. “We are talking about a level of debt that would certainly be unprecedented in modern history or in history, period. We are definitely at a tipping point.”  But once the coronavirus has been tamed and the country regains financial stability, US leaders will need to find an exit from the extraordinary levels of government borrowing.  Lynch:  “Building a consensus for the blend of tax increases and spending cuts needed to shrink the mammoth post-crisis debt will be tough to manage. Neither political party emphasized spending limits in recent years. And the presumptive Democratic nominee for president, former vice president Joe Biden, proposed relatively modest tax increases compared with his former rivals. Republicans, meanwhile, reflexively oppose tax hikes.”

 

In fact, over the last several decades, the United States, including the federal government, corporations, local governments and individual citizens have become addicted to debt.

“Total government, business and household debt now exceeds 250 percent of annual output, three-quarters greater than in 1980, according to government statistics . . .  An era of perpetually ultralow interest rates distorts the economy by eliminating the traditional market discipline that discriminates between worthy investments and unprofitable ones. If money is virtually ‘free’ for many years—as it has been since 2008—even bad ideas can attract financing.”  The result?  As the United States once again turns to debt to rescue the economy, it is locking in a future of lower growth. The “national credit card” is being used largely to stop today’s financial bleeding, rather than for investments—in the medical system, infrastructure and education—that would boost future growth.  [“Japan offers an example of what could await the US:  It has been stuck in an endless loop of disappointing growth, low interest rates and mounting debt and the United States could face a similar future.”  As Atif Mian argues, the United States seems ensnared in a “debt trap.”]

 

Here are several important facts about the national debt:

  • In the aftermath of the Great Recession, government debt, under President Obama, exploded as the United States ran annual trillion-dollar budget deficits for four years through 2012. But then in the final years of Obama’s administration, Washington embarked on spending cuts and tax increases that cut the deficit starting in 2013.
  • But, even before the COVID-19 crisis, President Trump’s administration significantly cut taxes and increased defense spending to the budget, which resulted in annual deficits of $1 trillion.
  • This year, the deficit will reach a postwar peak of 18.7 percent, according to the nonpartisan Committee for a Responsible Federal Budget. Only when the United States fought Nazi Germany was Washington bathed in more red ink.
  • By the end of September, the public debt will exceed $24 trillion, larger than the $21 trillion economy of the US, according to CRFB calculations. The recession’s impact will push the debt past the previous record of 106 percent of the economy, set in 1946.

 

Why is so much debt easy to absorb?  Today’s low interest rates make the massive federal debt relatively affordable. The government pays less than 1 percent interest to raise money by selling Treasury securities to investors.  “But Torsten Slok, the chief economist at Deutsche Bank Securities, says that interest rates are being kept low only by massive purchases that the Fed began last month to settle markets unhinged by the pandemic.   In March, to smooth out dysfunctional trading, the Fed began buying $75 billion worth of government bonds every day.

The Fed has cut back to daily purchases of $30 billion, but that is still a staggering amount of central bank support. At the peak of the Fed’s controversial crisis-fighting efforts in 2010, it was purchasing only $110 billion of government securities each month.  Today, it buys that much in less than four days.”

 

Wall Street Journal writer, Greg Ip, comments that: “In a debt crisis, investors worry the debt reaches levels the country may be unable to repay.  They refuse to buy its bonds, sending interest rates sky high, which simply adds to the burden of the debt.  But right now, the opposite is happening.  The Fed’s target federal-funds rate is effectively zero, and 10-year Treasury bonds are below 1% for the first time . . . [But] so long as the Fed can print dollars, it can lend as many of them as it needs, ensuring the federal government can always borrow.”  Lynch reports that most economists expect inflation and interest rates to remain low for years. But they could be wrong. Rising public debt is “the most important predictor” of future crises, including defaults, sudden increases in borrowing costs or runaway inflation, according to a January study by four economists at the International Monetary Fund.  “Governments should be wary of high public debt even when borrowing costs seem low,” the study concluded.

 

What about the debt of American corporations?  “For scores of companies that borrowed heavily in recent years, the pandemic is raising borrowing costs just as a fierce economic downturn obliterates their earnings and imperils their ability to repay their debts.  Total business debt topped $16 trillion last year. As the Fed reduced interest rates to zero in 2008 and kept them there for several years, companies took on more and more debt, including buying back their own stock and raising shareholder dividends.”

 

What about consumer debt?  “While household debt hit a record $16.1 trillion last year, it remains much smaller relative to the economy than in 2008.  But those statistics mask underlying vulnerabilities. Even as the majority of Americans firmed up their financial position, 40 percent—nearly 50 million households—have fallen further into debt since the financial crisis, according to Moody’s Investors Service.  The most indebted households also are likely to have family members lose their jobs in the wave of unemployment that is washing over the economy, according to Asti Sheth, Moody’s managing director for credit strategy. The nation’s four largest banks have set aside so far this year more than $18 billion to cover their anticipated losses on consumer and other loans, a level of reserves not seen since the 2009 financial crisis.

‘The distribution of debt and income is uneven,’ Sheth said. ‘And that is something we’re watching.’”

 

Are we at a tipping point in terms of debt?  Probably not, most economists would argue.  But, the projections always focus on interest rates remaining low, the Feds ability to simply print money and the certainty that for the near future inflation will remain low.  But the US is arguably in unchartered territory when it comes to its debt—it is so massive!  The nation is putting its debt on the shoulders of the next generation(s).  That fact alone raises significant concern.  If we are intellectually honest, that not only seems foolish; it’s nonsensical.

 

See David J. Lynch, “Record government and corporate debt risks ‘tipping point’ after pandemic passes,” in the Washington Post (19 April 2020); Greg Ip in the Wall Street Journal (24 April 2020); and Neil Irwin in the New York Times (28 March 2020).

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