The National Debt: How Bad Is It, Really?

If the fight over the debt ceiling and a U.S. default crashes the stock market…

I know exactly the first thing I’m going to say…

“This is so dumb.”

Because it is so dumb!

We’ve been here before, we’ve seen this all before…

Yet again politicians are having another fight over the “debt ceiling”...

 A self-imposed limit created by the U.S. Congress in 1939 to limit all accumulated debt to a fixed number: $49 billion.

A fixed number, by the way, that has been raised nearly 100 times in the last 80 years, regardless of which political party is in power. 

It’s $28.5 trillion now.

And in all the financial news outlets, we’re hearing the same old song that was popular in 1995… 2011… 2013…

Let’s call the song: “The Debt Ceiling Vote is a Stupid Political Stunt That’s Been Irresponsibly Weaponized for Partisan Gain… Blues.” 

It’s true…

The risk of default looms. By failing to raise the debt ceiling, the U.S. risks failing to pay its bills and obligations.

However, the proverbial can has been kicked by Congress yet again. They’ve raised the debt ceiling just enough to last until about December 3rd.

But with this topic in the news…

(And because my colleagues told me this would be a good topic to cover when I asked them for ideas…)

 It’s as good a time as any to talk about…

The Terrible, Horrible, No Good, Very Bad U.S. National Debt

As you can probably tell from my flippant tone…

If you’re a hardliner about U.S. national debt…

Convinced that this is a major issue and that the “fiscally responsible” thing to do is immediately begin paying or writing off some or all of the national debt…

You’re not going to like this article. Or what the data is actually telling us.

But oddly enough, there’s a compelling lesson here about wealth building buried under mounds of $#!&

Sorry...

I meant: Buried under the rhetoric that normally surrounds this topic with a fine, pungent mist of $#!&. 

I only ask that you look at the evidence with an open mind, understand where I’m coming from, and write to me if you think my data or conclusions are faulty. 

So if we’re going to talk about the U.S. National Debt, put it in context, and learn some lessons from it…

Let’s start with the scary chart that freaks everyone out:

The chart above is the percent of all government debt divided by the U.S. GDP. 

The U.S. government has a little over $28.5 trillion in debt…

And the U.S. GDP  —  the market value of the goods and services produced by labor and property located in the United States  —  is $22.7 trillion

As you can see, one number is bigger than the other number.

Indeed, the U.S. government’s debt is 125% of all the stuff the country produces in a year. 

The typical monkey-brained logical response to this fact is simple…

🐒: “Bad number big. Bad number need go down.”

And for most debt hawks (yes I’m mixing my animal metaphors, deal with it), that’s usually where the thinking ends.

(By the way, let’s not confuse debts and deficits. A budget deficit is the shortfall between what you make and what you owe. Debt is money you borrow and owe interest payments on. There’s a good argument that the federal spending deficit, which creates the need for the national debt, is too high. But that’s a topic for a future issue.)

There is evidence that having an overly high Debt-to-GDP ratio can (not will) harm a country’s growth prospects. 

A study from the American Economic Review found this on the topic (emphasis mine):

Our main result is that whereas the link between growth and debt seems relatively weak at “normal” debt levels, median growth rates for countries with public debt over roughly 90 percent of GDP are about one percent lower than otherwise; average (mean) growth rates are several percent lower… We find no systematic relationship between high debt levels and inflation for advanced economies as a group.

I’m sorry…

The thing people are freaking out and yelling on TV about… this crazy high debt…

The fear is that our median growth rate might be 1% lower than it otherwise might be?

Not negative. 1% lower than otherwise or worse. In just 50% of historical examples (because it’s the median). 

Hey, reader…

It’s October. A scary, spooky time. 

Are you scared, like really scared…

 🎃 🦇 💀 That U.S. economic growth might be 1% lower because our debt is so high? 

I doubt it.

Seriously! That’s what all this drama is about!

Simply put, this Debt-to-GDP ratio leaves out some important information. 

The most glaring one to me is this:

A country’s GDP doesn’t really indicate whether a government can pay its debts... or will. 

Case in point: Over half of all defaults on external debt since 1970 occurred when countries were at or below 60% Debt-to-GDP. (Source)

(Fun side note: 60% Debt-to-GDP is not a random number. It’s part of the “Maastricht Criteria,” a set of rules that EU member state economies had to follow before admission. The fact that so many defaults occurred regardless of this number should be a big hint to us that focusing solely upon the Debt-to-GDP ratio is stupid.)

Another case in point: The U.S. can continue to pay its debts if the Debt-to-GDP ratio keeps going higher. 

Let Me Try to Explain with a Hypothetical...

Imagine one year you take out a loan, and the interest payment on that loan is (let’s throw out a random number) 16.788% of your monthly income…

Reasonable right? 

You’re probably not going to go bankrupt paying off a loan that costs that little each month. 

Now imagine a few years go by and your income has gone way up…

And at the same time, interest rates on new loans are way down. After running the numbers, you determine a new loan would be so cheap that you’d still only be paying 16.788% of your monthly income to make all of your interest payments. 

That means, feasibly, you can take out an even bigger loan, cover all the interest payments easily, and your life would go on like normal... only richer, because you have more cash to buy stuff. 

Does that sound reasonable to you?

It should. 

This is essentially the logic behind refinancing a mortgage.

Now imagine this keeps happening. For decades.

Your income keeps going up. Banks keep lending you more and more money. The actual interest payments on these loans is still only 16.788% of your income.

Your Debt-to-Net Worth could be 60%… 125%… 1,000,000%…

As long as you’re able to easily make those monthly payments, it does not matter. You will keep getting loans. 

You can spend way beyond your means, and you can just float more debt to pay for your lifestyle… so long as that ratio to your income doesn’t get too high and you make your payments.

“But,” I hear you whine, “no bank would keep lending me money like that.”

And that’s true. 

The difference between you borrowing from a bank and the U.S. government is…

The U.S. Government lends money to itself.

Rather, the government issues debt in the form of treasury bonds. 

If you’ve ever heard or worried about a conspiracy concerning the world adopting one global currency… 

I hate to break it to you, but it already happened a long time ago. 

The world runs on U.S. treasury bonds. 

About 60% of the world’s currency reserves are denominated in U.S. dollars.

About 70% of global currency usage involves U.S. dollars.

(Source for all these numbers.)

Why?

Because most of the world’s currency stockpiles and transactions involve U.S. treasury bonds, which are widely considered to be a safe, stable store of value. 

(That goes away, by the way, if the U.S. defaults on its debts. Another reason why this debt ceiling showdown is so irresponsible.)

Long story short…

It’s not the sheer amount of debt that poses a risk to the U.S. economy…

It’s the share of debt payments to the U.S. economy.

If you want an apples-to-apples comparison with the earlier Debt-to-GDP chart, here is a chart of the U.S. government interest payments divided by the GDP:

As of 2020 that number was about 1.65% — it’s probably a little higher in 2021. 

But still, this number? The actual cost of paying the debt compared to the U.S.’s GDP? 

It’s barely a blip. 

And I think that’s one reason why politicians use the scarier Debt-to-GDP number instead of this one. 

When you compare the cost of debt to the GDP, this conversation doesn’t seem really, like, urgent? Anymore?

Someone getting upset about 1.65% “being too high” would make for bad TV, is what I’m saying.

As I said before, though… 

GDP isn’t a good number to use here, in my opinion.

So let’s look at this a different way…

Here’s a chart comparing all of the tax revenue (blue line) brought in by the U.S. to all of the interest payments (red line) it needs to make to service its debt. 

One thing that should jump out at you immediately is that the revenue the U.S. government is bringing in (from taxes) far outpaces the cost of its debt obligations...

And the actual percentage of these payments to its income is fairly low. 

How low?

You probably guessed it: 16.788%.

Debt-to-income is one of the ratios lenders and banks use to assess whether they’re going to give you money. 

If you speak to any lender, they’ll likely tell you that they’re looking for borrowers to have a debt-to-income ratio is less than 43%

As you can see, one number is smaller than the other number.

And I am hoping that the monkey-brain response has transformed into more of a big-brain response…

🧠: “Oh. This is fine.”

It Hasn’t Always Been Fine, Though...

Here’s a chart of that ratio of interest payments to Federal government tax receipts over time:

As you can see for the past 20 years… 

Despite three recessions, several stock market crashes, wars, terrorist attacks, two Democrat presidents, two Republican presidents…

This ratio has remained below 20%. 

The U.S. has been fine to take on more and more debt because the government’s tax revenue has continually grown for decades at an increasing pace.

But I don’t think it’s any coincidence that this number — the cost of interest payments to tax receipts — more than doubled between 1980 and 1985 and stayed there for 10 more years…

Right after the U.S. had its one and only default in history in 1979.

What happened was: The Treasury department failed to pay treasury bill investors $122 million on time due to a computer backlog. 

Even though they were all were repaid, with interest, within 10 days… 

The damage was done. This was technically a default.

And the cost to the U.S. economy was enormous. 

A study in 1989 found that this single, small mishap caused the yields on treasury bills to go screaming higher...

And stay high. 

That’s because confidence in the stability of the asset goes down when there’s a default. That’s why so many bonds issued by unstable governments pay 12% to 15% returns.

There’s no trust, so the debt issuer has to promise higher and higher yield payments…

(See also the Evergrande crisis that’s unfolding.)

And when government debt yields get high…

The cost of mortgages goes up…

The cost to borrow money from banks goes up…

The price of stocks goes down…

There are consequences, is what I’m saying. 

I don’t know if you remember the 1980s, but I do. And they weren’t great.

That’s what’s at stake in this whole debt ceiling fiasco.

Here’s Another Way to Frame This Stupid Debt Ceiling Fiasco

Imagine you own a restaurant…

And the United States ate at your restaurant.

The bill for the meal comes to $16.78…

But when you give the check to the U.S., the U.S. pulls out $100 in cash…

Looks at you…

Looks at the bill...

And says, “Nah I ain’t paying,” and then leaves. 

Would you, as the restaurant owner, ever allow the U.S. to eat there again?

I doubt it.

That’s basically the situation in Washington. 

The U.S. is able to pay.

The U.S. is able to borrow some money so it always has cash on hand to pay for things.

But by failing to raise the debt ceiling…

Monkey-brained politicians are basically saying... 

🐒: “Let’s just… like... not? Pay for stuff?”

This is why the debt ceiling debate is so dumb to me. 

There shouldn’t be a cutoff at some specific, magical debt number…

A number that politicians will fight over every two years to score political points. 

A better, more financially responsible limit (if we need a limit) might be some percent of what this country is capable of paying on a regular basis. 

Because, hey presto, that’s literally one of the numbers lenders use to assess default risk.

Some Final 🐒🧠 Thoughts

Listen…

Debt is neither good nor bad. 

It’s a financial tool that can be used or misused.

That’s true whether you’re a government or an individual taking out your first mortgage to buy a house. 

But you know what’s always bad?

Defaulting on debt. 

A debt is a covenant, a bond of trust that comes with expectations and obligations.

And if you fail to live up to that trust…

You’ll have to go to more and more extreme lengths to earn that trust again. 

And if you value financial conservatism, as I do…

I hope you can see that the fastest way to wreck the U.S. economy and increase government spending is to risk or go through a default. 

Next week, I promise to make more points using emojis…

And maybe, actually share an investment I’m excited about. 

Sean "Finance Daddy" MacIntyre

The Finance Daddy, a.k.a Sean MacIntyre, is a seasoned investment analyst, entrepreneur, and marketing consultant to some top dogs in the financial industry. Since 2015, he’s served as acting private portfolio manager and head equity analyst for a multimillion-dollar international investment trust. Sean’s work reaches over 22,000 readers. To learn more about him, read his bio right here.

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