The U.S. National Debt Level: Is The Sky Really Falling?

The Sky is Falling! Or is it?

I believe one of the most misunderstood areas of the U.S. economy today is the disdain shown by the average American citizen over the current level of the United States’ national debt which now totals $9.4T. Yes, currently the U.S. Government owes a collective $9.4T to American households, American institutions, and foreigners since the U.S. government has spent in excess of its tax revenue during most years, which, in economic speak is called “deficit spending”.

The shear magnitude of the U.S. national debt ($9.4T), coupled with alarmist comments by the U.S. Congress and the American press lead most Americans to conclude that our country is in a very precarious position and has perhaps grossly mismanaged its financial affairs. Moreover, more Americans are becoming aware that future Federal payouts for social security and Medicare alone, assuming current benefit levels, will rise at a much faster rate than the current tax revenues for those same social programs.

Well, guess what, I am here to tell you the concern is vastly overstated!

THE IMPORTANCE OF DEBT TO A COUNTRY (OR AN INDIVIDUAL)

Contrary to what many Americans believe to be conventional wisdom, debt is actually a beneficial and recommended pursuit, if used correctly, since it enables a nation or an individual to equalize income and expenditures over time, and improve standards of living earlier than what would otherwise be attainable. It is easier to accept this premise on the personal front as millions of Americans have been able to improve their standard of living currently by pulling their future incomes forward via borrowing to purchase homes, cars, and education. Of course, we all know that debt, like a car, can cause damage if it is not used and managed wisely, and that is where many alarmists focus, and even some go so far to say that all debt is bad and should be avoided. Many nations, with Russia being a prime example, have been criticized by noted economists for not utilizing enough national debt to improve their economy and their citizens’ standards of living. Thus, hopefully, with a conclusion that debt can actually be a ”good thing”, if used for productive purposes, one can then proceed to the next section as to what are acceptable levels of national debt.

$9.4T: AN ACCEPTABLE LEVEL OF NATIONAL DEBT?

The United States’ current level of national debt is both affordable and consistent with most all other nations. National accounting statistics show clearly that the U.S.’s 67% national debt/GDP percentage is roughly average compared with other modern economies, about right smack in the middle. Moreover, the level of U.S. national debt as a percentage of GDP (67%) is at the same ratio as it was back in 1997 and 1992, and is much less than it was in 1950! The ‘”trick” is that debt must be benchmarked to the size of a nation’s economy or income. I find it interesting that if I tell someone that Bill Gates owes someone $10M they quickly deduce that he’s probably fine, but if I tell the guy at Starbucks that the U.S. owes $9.4T they think the country is screwed up!

One additional benchmark is to compare the annual interest paid on the U.S. national debt ($0.4T) relative to current U.S. federal tax revenue ($2.8T) to the percentage of household interest paid as a percentage of household disposable income. Both benchmarks are currently at a 14% ratio indicating that Uncle Sam’s (U.S.) debt load is actually very consistent with Uncle John’s (households).

Much has also been made of the fact that $2.4T of the U.S. national debt, or 26%, is owed to foreigners. Big deal! It sounds scary on the surface, but once you understand it is pretty harmless. Let me explain. Foreign debt is nothing more than saved U.S. dollars which will eventually be spent back into our economy. Foreigners have temporarily not purchased our products (foreigners have U.S. dollars because we bought their products!) and have temporarily lent their dollars to the U.S. Government to finance the U.S. Government’s deficit spending. Debt held by foreigners is “dollar savings” just like debt held by American citizens is “dollar savings”, so, in other words, it is really not that important whether the debt is held by foreigners or US citizens since eventually those dollars will be spent back into the U.S. economy since they can’t be spent in another economy! By the way, the U.S. national debt owed to China is only 5% of the total debt but the newspapers make it seem like 50%.

SO IT MIGHT BE AN ACCEPTABLE LEVEL OF U.S. NATIONAL DEBT NOW, BUT WHAT ABOUT THE FUTURE?

Many have argued that the U.S. aging population coupled with the flood of “baby boomers” moving into their retirement years will cause social security and Medicare alone to “shoot through the roof” and cause the U.S. national debt to reach unacceptable and unmanageable levels, potentially, some say, even bankrupting the U.S. Government. Many use extrapolations of future social security and Medicare payments out into varying distant futures based on the number of retiring baby boomers and increasing life spans concluding that there are trillions of unfunded government obligations ($10T, $25T, $80T, etc.) which are insurmountable. The problem with most all of these analyses are that they fail to address how simple and relatively small adjustments make these problems disappear. For example, on social security, an increase in the social security tax rate from its current rate of 12.4% (6.2% for employees matched by employer) to 15.9% is deemed by one source to fully fund social security at today’s benefit structure out into perpetuity (i.e., forever). Similar analyses are out there for other actions such as updating social security retirement ages to be more consistent with longer life spans. Now granted, few would be happy with a 28% increase in their social security taxes paid or later retirement ages, but what will likely happen will be a combination of different types of changes including reduced benefits, higher taxes, later retirement ages, and reallocations of the overall federal budget.

CONCLUSION

Today’s current level of U.S. national debt is within our government’s means, is an “average” level of national debt compared to other modern economies, and has been an instrumental and, thus far, a necessary part of our country’s economic success. One should never be concerned with the increase in the nominal or absolute amount of the national debt, but rather it should be measured in relation to the corresponding growth in our nation’s economy, usually nominal GDP.

The U.S. economy has some sizable challenges ahead in terms of keeping our increasing national debt in line with increases in our economic growth. Most notably, our demographic trends of fewer births and increased retirees with longer life spans will put additional strains on our country’s debt/income relationship.

One needs to be aware of the increasing number of doomsayers and alarmists who quote projections that are too one-sided and do not paint a fair picture of our challenges ahead. Within the next several years, relatively small changes involving increasing tax rates, lowering government spending, redefining retirement & health benefits, and delaying eligibility of benefits to coincide better with increasing life spans will be necessary to position America into the future.


Originally posted at Welker’s Wikinomics Blog and reproduced here with the author’s permission.

7 Responses to "The U.S. National Debt Level: Is The Sky Really Falling?"

  1. Guest   June 27, 2008 at 7:20 am

    Medicare

  2. villager   June 27, 2008 at 9:45 am

    I disagree with the entire thrust of this article. It ignores fundamental changes and erosion in the US economy and society – an economy that is increasingly dependent on the production and use of military goods and services; a consumer driven economy that is being starved of home-grown innovation and talent; an income distribution that reflects a worsening in the well being of the majority of the country’s citizens; and, decision makers and citizens who scream foul whenever foreigners actually exercise control and authority over the assets that Americans can no longer afford. This author trivializes a very serious problem. As a country, Americans deserve the destiny that they get.In the other blog today, LondonBanker discusses the Rosy Scenario. I believe the author of the debt article is a believer in the ‘rosy scenario’ because that is what he has laid out.

  3. me   June 27, 2008 at 10:29 am

    I agree with villager. Nothing is going right for the US consumer. [email protected], home prices falling (>20% yoy), stock market at the worse June since the Great Depression, consumer sentiment/confidence at record lows (as it has been only during recessions in the past) and a HOUSEHOLD DEBT/INCOME RATIO at 140%, hh debt/service ratio near record at 14.3%.Those are the things to worry about, and there is not much room for fiscal policy to tame the effects of a recession with stimulus packages at this point.

  4. christian   June 27, 2008 at 11:30 am

    http://www.cepr.net/documents/publications/housing_crash_baby_boomers_2008_06.pdfThis paper extrapolates from data from the 2004 Survey of Consumer Finance to project household wealth, by wealth quintile, for the cohort that will be between the ages of 45-54 in 2009 under three alternative scenarios. The first scenario assumes that real house prices fall no further than their level as of March 2008. The second scenario assumes that real house prices fall an additional 10 percent as a 2009 average. The third scenario assumes that real house prices fall an additional 20 percent for a 2009 average. (Real house prices are currently falling at the rate of approximately 1.5 percent a month.)The projections show that the vast majority of families in these age cohorts will have little or no wealth by 2009 in any of these scenarios. In the first scenario, families in the 45 to 54 age cohort in 2009, who were in the middle grouping of the wealth distribution in 2004, will have on average just $113,600 of wealth in 2009, 26.2 percent less than families in this age group in 2004. In the second scenario, families in the middle quintile will have $97,600 in wealth, 36.6 percent less than families in 2004. In the third scenario, families will have $81,500, 47.0 percent less than families in the middle quintile for this age cohort in 2004.Families in the second wealth quintile are projected to have just $35,400 in wealth in 2009 under the first scenario and $22,700 under the third scenario. Even families in the fourth wealth quintile are projected to have just $250,200 in wealth in 2009 under the second scenario.These projections show that the cohorts just approaching retirement will have very little to support themselves in retirement other than their Social Security. This means that any cuts in Social Security and Medicare below current levels are likely to impose serious hardships on all but the wealthiest families.

  5. Little Saver   June 27, 2008 at 11:32 am

    Against this rosy view on American debt, I’d like to place an alternative view, coming from the 2007 financial report of the US government, issued by the secretary of the American Treasure Henry M. Paulson to the Congress and the American people. Page 32: "The federal government’s fiscal exposures totaled approximately $53 trillion as of September 30, 2007, up more than $2 trillion from September 30, 2006, and an increase of more than $32 trillion from about $20 trillion as of September 30, 2000.7 This translates into a current burden of about $175,000 per American or approximately $455,000 per American household." I think that the disdain shown by the average American citizen over the current level of the United States’ national debt and more specific over the way that their money is spent on non-productive (and even destructive) projects for the benefit of a small minority at the top is more than justified. One-sided rosy thought constructs to minimize and cover this reality aren’t accepted anymore by the average citizen. No, Mr. Average is not thinking that the sky is falling. Mr. Average sees too much of his tax money wasted on non-productive projects for the benefit of an elite minority.

  6. Gleep Glop   June 27, 2008 at 12:07 pm

    What disturbs me is not the level of debt that the federal government has but the level of tax supported debt that the entire government, State, local, regional has. When you compare the US debt to overseas debt of countries which do not simply have debts at these myriad other levels or to the scale of the US, you clearly are making an invalid comparison. Whereas the US will pay its debt, Detroit and Michigan most likely will not and that debt will be put back to the Fed increasing the overall Federal Debt. Incorporate the debt that the states and localities have into the entire picture, which I have yet to see on a sytemic basis, the result will be I assume less rosy."Hey Gleep Glop get me another one of them space beers"

  7. Leslie the Realist   July 3, 2008 at 4:50 pm

    A growth graph from the Federal Reserve, courtesy of BNP Paribas Economic Research, shows the terrible news that growth in U.S. household real estate assets and growth in their financial assets have both plunged to literally ZERO! (The chart goes back to 1960, and it has never happened before!)The latest report is that the combined Net Worth of all U.S. Households is $56 Trillion, which is LESS than the $57 Trillion accrued Federal Government’s Liabilities, meaning that the United States and its citizens are technically BANKRUPT!The typical American family now has only 19 days of reserves set aside for any emergency. Aside from the upper well-heeled 20% of the U.S. population, the average American lives from paycheck-to-paycheck and is simply flat-out broke and drowning in debt.