In part three of our national debt masterclass, we share a simple debt dynamics formula we can monitor to help guide our investment choices.
Topics covered include:
- How much has the national debt grown over the past fifties years, and what are the underlying drivers
- How the budget deficit, interest rates, and economic growth determine the level and growth in the national debt
- Under what circumstances will the U.S. default on its debt
- How should we invest to protect ourselves from the uncertainties of the national debt situation
Show Notes
Jerome Powell: Full 2024 60 Minutes interview transcript—CBS News
Yellen says she disagrees with Moody’s outlook on US debt by Ann Saphir and David Lawder—Reuters
IMF Steps Up Its Warning to US Over Spending and Ballooning Debt by Christopher Condon—Bloomberg
WHEN DOES FEDERAL DEBT REACH UNSUSTAINABLE LEVELS?—Penn Wharton
The Long-Term Budget Outlook: 2024 to 2054—Congressional Budget Office
PUBLIC DEBT AND LOW INTEREST RATES by Olivier J. Blanchard—NBER
Term Premium on a 10 Year Zero Coupon Bond—FRED
Instantaneous Forward Term Premium 10 Years Hence—FRED
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Related Episodes
478: National Debt Master Class Part 2/3
477: National Debt Master Class Part 1/3
Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 479. It’s our finale in our three-part masterclass on the national debt.
National Debt Principles
In the past two episodes, we’ve reviewed some important principles when it comes to federal government borrowing.
First, the national debt will never be paid off. It will just continue to be rolled over, and potentially grow over time. What matters is the size of the debt relative to the economy, the private sector economy that creates the bulk of the income pays the taxes that are used to service the debt. That private sector owns much of the debt in the form of assets.
A second principle we discussed was how the federal government, working with the central bank, can control the terms of the debt issuance, including controlling the interest rates through what is known as financial repression. Now, even though governments can do that, they don’t get a free pass. The private sector can decide whether they want to hold the debt or hold the currency that the debt is denominated in.
If the central bank coordinating with the government is buying up the debt, monetizing the debt at the same time the government’s running a budget deficit, that leads to big increases in the money supply, which if there are capacity constraints, can lead to much higher inflation, and that’s something we’ve seen in the US over the past few years. Consequently, there are consequences to government borrowing and government money creation. Too much of it can overwhelm the private sector, leading to inflation.
Now, in part three, we’re going to look at a simple formula to understand where are we; at what level is the debt too high, where a potential default becomes a reality, even if that default is through monetization/higher inflation because the private sector doesn’t want to hold the debt. If we go back to 2008, just prior to the Great Financial Crisis, the size of the US national debt, the publicly-held debt as a percent of economic output or GDP—that’s the best way to measure it; the size of the debt relative to the economy—it was 35% in 2007. The lowest it got was back in 1974, at 23.2%.
An Unsustainable Fiscal Path
Now, there are various entities that project the level of the national debt going forward. The most renowned is the Congressional Budget Office. This is a federal agency that produces nonpartisan, independent analysis of the impact of US government’s budget, new bills, and then projects out levels of the national debt.
Back in 2008, the Congressional Budget Office issued the report—they do this annually—and they expected that in 2014, that debt to GDP six years later would be between 60% and 69%. And the actual debt to GDP amount in 2014 was 74%. The amount was higher than the prediction. There’s a pattern here.
In 2014, the Congressional Budget Office predicted that in 2023 debt to GDP would be 78%. The actual was 99%. Now the Congressional Budget Office predicts in 2034 that debt to GDP will be 139%. The amount is increasing relative to the size the economy, and we could get at a level where it’s too high, and people don’t want to hold the debt, leading to a spike in interest rates.
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