The U.S. national debt is now at its statutory ceiling of $16.2 trillion, which means that the government, at the rate at which it spends money, will run out of cash sometime around Feb. 15. There is certain to be a fierce fight over whether to raise the debt limit: Republicans want substantial spending cuts to nearly everything except defense, while Democrats want to make minimal cuts but hold the line in spending while the economic recovery continues to gain momentum. The last time that debt ceiling talks were held, in 2010, the unwillingness of Congress to allow it to be raised caused the credit rating agencies to downgrade the quality of U.S. Treasury securities, something once unthinkable in conventional economic theory, which is based on the credit worthiness of the U.S. as the baseline for all other credit assumptions.
The U.S. national debt, 73% of American GDP, according to the non-partisan Congressional Budget Office (CBO), 105% of GDP if you include all sorts of other government obligations not normally considered by conventional accounting rules (this includes items such as agency debt, which is paid for out of revenues directly earned by the agencies, such as public finance bonds that are paid for by tolls and fees), is not really high by either historical standards – it reached 109% at the end of World War II – or by international standards, either. France and Germany have debts that are around 85% of GDP. Italy is at 121%, and Japan is at 202%.
But it is not the size of the current debt that Congressional leaders are really worrying about. It is the size of the future debt. When Tea Partyers begin complaining about strapping their grandchildren with debt, it is that they worry about the growth of the Federal debt relative to the growth of the economy. Again, according to the CBO, the debt, if left unchecked, will rise to 109% of GDP by 2026 and that it would approach 200% by 2037. But we know that won’t happen. How do we know it? Even before the changes in the tax code signed into law by President Obama in early January, the growth of the economy, in the form of higher tax revenues, was already beginning to work its magic. Under a CBO scenario that forecasts modest growth, plus the rise in new taxes, debt as a percentage of GDP could begin to fall within the next year or two. Had all of three Bush-era tax cuts been allowed to expire, debt as a percentage of GDP would have declined to 61% of GDP by 2022 and 53% by 2037. But nobody – Democrats or Republicans – wanted to raise taxes on the middle class or those earning even less – so the decline will take a bit longer and be a bit slower to take effect. If, of course, spending can be held in check. It does not, in fact have to decline, but it should not be allowed to continue to rise at the pace it has risen over the past decade.
All of this does not really answer the question of why we worry about debt as a percentage of GDP in the first place. When you walk into a bank and ask for a mortgage, the bank does not look at your current year’s income alone – your personal domestic product – in making its decision. Rather, the bank evaluates your wealth – whether you own your cars, how much money you have in savings and investments, the kind of job you have and your promotion history – to figure out how much debt you can afford to take on. In other words, your bank evaluates your wealth, not your income.
The idea of looking at national wealth as a measure of debt affordability goes back at least as far as 1086, with the survey of England’s national wealth – livestock, land and money – ordered by William the Conqueror in order for him to know what taxes he could assess and how much he could borrow to fight his wars. Flash forward 690 years, and there is Adam Smith writing not about the income of nations – GDP – but rather, “An Inquiry into the Nature and Causes of the Wealth of Nations.”
So how wealthy is the U.S.? In an interesting book published in 2008 by The World Bank and soon to be updated, titled “The Changing Wealth of Nations,” economists at the bank considered three types of wealth: Produced capital, which comprises machinery, structures and equipment; natural capital, which comprises agricultural land, protected areas, forests, mineral, and energy; and intangible capital, which is human social and institutional capital. On that basis, the wealth of the United States stood at $217.6 trillion in 2005. Given that the wealth of the U.S. was just $155.8 trillion a decade earlier, we can calculate a cumulative annual growth rate of nearly 4%. Even discounting growth substantially for the recession and the slow growth years of 2006-2012, it leaves us with a figure just shy of $250 trillion at the end of 2012. By contrast, China, the nation that is supposedly going to supplant the United States in coming years, has a national wealth of about $42 trillion, about one sixth the wealth of the U.S.
In per capita terms, the contrast is even more stark. Only three nations – the U.S., Denmark and Switzerland – have per capita wealth figures above $700,000, but Denmark and Switzerland are tiny nations, so their aggregate totals are minuscule by comparison. Looked at in this fashion, and it’s the way it really ought to be looked at, the national debt is a mere 6.4% of national wealth. Not a rounding error, exactly, and certainly nothing to be dismissed, but the debt ceiling, to quote the Beatles, is “nothing to get hung about.”
But let’s look at it from a bottom up perspective. According to the U.S. Treasury Department, the Federal government paid out just shy of $360 billion in interest on its debt in fiscal 2012. That’s a debt service of 2.2%. Going back to the home mortgage analogy for a moment, any bank looking at a debt service cost that low would be falling all over itself to lend you more money. And in fact, that’s exactly what’s happening. If you’ve been wondering why other nations are happy to buy Treasurys even though they pay essentially zero interest, or why the dollar is continuing to rise, now you know the answer.
The bottom line: Whether you asses the debt from the top down, as a percentage of wealth, or from the bottom up, looking at the cost of debt service as a percentage of national income (GDP), the argument that the debt is something that is a) out of control or b) to be worried about right now is bogus, and in some regards, an outlandish distortion of reality.
On the other hand, how we generate growth is a subject that so far has not gotten much in the way of serious discussion, but in the past, when a President has made his claim that stimulus via borrowing is needed, Congress has acceded to his wishes. If President Obama is wrong, there is more than enough time to reverse course within four years, and more than enough borrowing capacity to keep us from becoming Greece, as some of the more hysterical and cynical political voices have suggested.
In my mind, the real question America should be addressing is not quantitative, like the level of debt, but more qualitative, which is often how decision makers rather than computers make choices. Having traveled extensively through Europe, Latin America and Asia, I think the one catalyst that creates economic growth is a profound sense of opportunity rather than stimulus. People will go back to work, employers will resume hiring, when uncertainty goes out with the tide and opportunity comes to replace it. That’s the key question that Obama and his second administration should be addressing.