The title of this article is phrased as a question, not because I have the answer, but because it is a very important question we should be asking ourselves. As a child, my parents taught me that there were consequences to my actions and decisions. If you were not lucky enough to have parents that taught you this, I am sure life has allowed you to experience this truth first hand. During this time of stimulus spending, tax cuts, and bond-buying by the federal reserve, I find myself wondering what the consequences of all of this debt will be? In this article, I will cover possible consequences of the debt we have accumulated (and continue to accumulate), as well as factors that will either help or hinder our ability to manage this debt load.
The first thing we need to do is identify if there is a debt problem, and if so, just how big is this debt? At the time I wrote this article, the U.S. had a total debt load of over $24 trillion dollars. Although $24 trillion is a huge number, it has little meaning until we compare it to other numbers like GDP (Gross Domestic Product) and Tax Revenues. There is no real consensus among experts, but most agree that we cannot continue at the same pace we have been accumulating debt. The graph below from Statista.com shows our national debt compared to GDP historically and shows projections for the next several years.
As you can see from the graph, we are approaching all time record debt to GDP levels. The only other time we have had levels this high was shortly after World War II. However, many still say that the current debt levels in the U.S. are sustainable. Usually, this statement is followed up with “as long as interest rates are low”. Interest rates, in my opinion, are the key factor to the overall debt conversation. The U.S. Government, just like you and I, has to pay interest on their debt For the last 12 years interest rates have been very low. Take a look at historical rates for a 10 year treasury bond in the graph below:
What happens if interest rates rise? Well, the cost of carrying this debt increases. If interest rates rise and remain high, then even our current debt load could become a real burden. Take a look at another chart from the Peter G. Peterson Foundation. This graph illustrates how the interest expense associated with U.S. debt can quadruple in only 10 years.
We have been fortunate that interest rates have remained low. Can interest rates stay low forever? I doubt it, but they can stay low for a long time. As long as inflation remains low, we can keep interest rates low as well. Very few experts are concerned about rising inflation now or in the near future. This means that we will likely have an opportunity to address our debt before it gets out of hand.
In my opinion, we have a small debt problem at the present time, but if we don’t change course it will become a big problem in the future.
How do we reverse course? How do we prevent a big debt problem? First of all, we should hope for interest rates to remain low and the economy to continue to grow. Secondly, we need to balance the budget. This can be done through increased tax revenue and/or spending cuts. In 2020, total expenditures for the U.S.government are projected to be $4.75 trillion and tax revenue is projected to be $3.64 trillion. That is a deficit of $1.103 trillion in 2020 alone. Deficits force the U.S. to go deeper into debt. This may be simple math, but politically, it is difficult to increase taxes or cut spending. Neither party has been fiscally responsible because it is hard and unpopular. We, the people, need to demand fiscal responsibility!
If we are lucky, the U.S. economy will have strong growth in the next 10+ years, and as a result, tax revenues will increase naturally. Furthermore, when the economy is strong it can handle spending cuts, and tax increases much better than during a recession. I don’t believe that we can count on prolonged economic growth. It may happen; it may not. Similar to personal financial planning, I believe we need to hope for the best and plan for the worst.
Best case scenario:
I believe we can fix our debt problem. If the economy continues to grow, interest rates remain low, and we make some adjustments to spending and taxes, we will be able to significantly reduce our debt to GDP ratio and our projected interest expenses.
Worst case scenario:
If the U.S. economy has a prolonged period of no growth or a recession mixed with inflation (a.k.a. stagflation), it will be difficult to improve our debt situation. A shrinking economy means lower tax revenues. Inflation means increasing interest rates, and increasing interest rates mean higher interest payments on our debt. In summary, less inflows and more outflows is simply a recipe for more debt. We could try and increase taxes and/or cut spending now, but that is the last thing you want to do during a recession.
Somewhere in between:
In my opinion, growing out of our debt without any consequences is very unlikely. Stagflation is also very unlikely. I believe the most likely scenario is somewhere in between. I would not be surprised if we continue to spend more than we bring in, interest rates and inflation remain low for a while, and the economy continues to grow at a slow rate with a recession every now and then. This scenario could give us the precious time we need to balance the budget. We may be able to continue on our current trajectory for 10 or even 20 years, but that would leave the burden of all this debt to the next generation. Furthermore, a balanced budget and minimal debt can give us the flexibility and leverage we need to weather whatever storms we have in the future (wars, pandemics, recessions, etc.). Excessive debt makes us more vulnerable.
I believe in the United States, the resilience of our people, and the strength of our economy. I am confident that the U.S. will remain the best country on the planet for a long time, but our current fiscal policies are putting the long term health of our country at risk. Coronavirus and the current economic downturn make this a really poor time for tax increases and spending cuts. As the economy recovers, we, the voters, should look for level-headed politicians who are willing to make some tough decisions and put the long term health of this country as their number one priority.
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Written by Brandon Carter