As the U.S. debt ceiling approaches, some facts on U.S. government borrowing


U.S.Treasury Building facade, courtesy of flickr.com

The U.S. government is fast approaching it's current statutory debt ceiling, the limit on how much it can borrow. After September 29, the Department of Treasury anticipates it will no longer be able to pay the government's bills, including interest due to holders of government bonds and notes, including payment of interest to holders of U.S. bonds and notes, which are supposedly the safest financial investment vehicle for U.S. investors and savers and indeed for investors around the world. The White House has asked Congress to raise the debt ceiling, though Trump was critical when Obama requested debt ceiling relief.

In most years U.S. government spending is higher than revenue, resulting in an annual budget deficit. But there have been years when the budget has been in surplus, most notably in 1948-1949 after WWII, in 1956-57 and 1961 during the Dwight Eisenhower presidency, in 1969 before the big push in Vietnam and most recently in 1998-2001 during Bill Clinton's presidency. Each year of a government deficit adds to the total U.S. government debt. A surplus reduces the debt. Since in most years the government budget produces a deficit, the U.S. government debt has grown.

The U.S. Congress passes the laws that determine how much the government spends and how much revenue it takes in each year. In passing these laws it is Congress that determines how much the government must borrow each year. But Congress has also passed a law that puts a limit on the total government debt, even though it is the laws that Congress passes that lead to the need for the borrowing. So periodically, when total government debt hits the debt ceiling, Congress must pass a law increasing the debt limit, or cause the United States to default on it's payment obligations.

Most economists and financial professionals believe a United States default on its debt obligations would put the U.S. and the world's financial system in chaos. Interest rates would spike up, and a financial crisis would ensue and a likely world recession would result. Americans who own any stocks or bonds — even if the bonds are not from the U.S. government -- will see the value of those investments drop. This includes the values of mutual funds, IRAs, pensions and 401(k)s.

And it is unthinkable that Social Security checks may not go out to recipients, to say nothing about Medicare and Medicaid payments to health care providers.

In light of what is at stake, It is good to know some detail on U.S. government debt. How big is it? To whom is it owed? Will it be a burden on our children?

U.S. government debt, how big?

As of August 1,2017 total U.S. federal government debt "owed to the public" was $14.8 trillion. To put this in perspective, the U.S. economy currently produces (our GDP) about $19 trillion of income or product annually.

In addition to the debt "owed to the public" there is $5.4 trillion of federal "interagency debt" or debt that one part of the government owes to another part, $2.85 trillion of this is the current surplus in the Social Security Trust Fund. This is not really debt in the traditional sense. It's as if you were to take your monthly income and put part of it in your right pocket and the other part in your left. As you spend over the course of the month the money in the left pocket begins to draw down, so the right pocket makes a loan to the left. This may make you feel more balanced, but it is not an increase in your debt, and neither does the surplus in the Social Security Trust Fund add to total U.S. government debt "owed to the public."

The reason why we put quotes around "owed to the public" is because most of this $14.8 trillion U.S. government debt is owed to U.S. citizens, businesses and financial institutions, but not all of it. $6.1 trillion is held by foreigners, by foreign central banks, financial institutions and foreign businessmen and other foreign citizens. Citizens and institutions in China and Japan are the biggest holders of this debt to foreigners, They each hold about $1.1 trillion of U.S. government bonds and notes.

Is the debt a burden being left to our children ?

It is often said that the debt is a burden that we are leaving to our children. Some commentators even contend that this is immoral. But that is not accurate, since some of our children will be owed the debt, the ones who bought or who inherited government bonds, we could just as easily describe the U.S. government debt as assets that we are leaving to our children. And it doesn't take into account what was bought by the government borrowing that created the debt. That government expenditure, if used wisely may leave a positive legacy to our children and grandchildren, for example, a stronger defense against foreign adversaries, a possible more peaceful world because of successful diplomacy, better infrastructure and public transportation networks, scientific breakthroughs in health and energy and technology funded in part by government, a more equal distribution of income that yields more justice and social peace and tranquility, and the support and care it gave to our children's parents and grandparents via Social Security and Medicare.

Is the debt owed to foreigners a problem?

The $6.1 trillion of U.S. government debt held by foreigners could be considered a problem since it represents foreigner's claims on U.S. goods and services. On the other hand it also represents some degree of confidence that foreigners have in the U.S. economy, otherwise why would they invest in U.S. bonds?

Foreigners who hold U.S. government bonds can sell them for dollars and use those dollars to buy U.S. produced goods, services and real assets in the United States. But it is unlikely all these foreign held bonds would be sold suddenly and simultaneously by all foreign holders of U.S. bonds, since it would send the prices of those U.S. bonds sharply downward and cause a loss of value for the holders. And if large amounts of these bonds were to be sold suddenly it would raises interest rates on those bonds, providing incentive for the holders to keep them rather than to sell and slowing down the sale or stopping it altogether.

But here is where there is a grain of truth to the notion that the U.S. government debt is a burden we are leaving our children. In the future, as foreign holders of U.S. bonds gradually redeem the bonds for dollars or are paid interest in dollars on the bonds, they can use the dollars to buy U.S. goods and services. As they do this, it leaves a smaller share of those goods and services for our children and grandchildren to enjoy. But even this should be balanced against the positive things that the original borrowing by the U.S. government allowed us to pass on to our children and grandchildren.

What the government does with the borrowing is crucial

Like all borrowings, what is critical is what the government does with the money. Much of the borrowing that was done in aftermath of 2009 Great Recession was instrumental in the struggle to get the U.S. economy back to full employment. That borrowing allowed us to stimulate demand for goods and services leading businesses to hire more workers to increase production, to minimize deterioration in worker skills that results from long term unemployment and to eventually get us back to a full employment economy. So government borrowing in a recession economy is necessary. Without it, there would be far more loss of income for the American economy and the American people in recessions and too many painful years of too many Americans without jobs far longer than necessary.

Even in a full employment economy government borrowing can be a wise choice if we were to use the funds for investments in our infrastructure, for improved roads and bridges and highways and investments in education and skills training and apprenticeship programs to improve the skills of the workforce and in research to improve treatments for illness and breakthroughs in energy and to combat climate change. But having said this, it is far better for these kind of borrowings for government investments like this to take place when unemployment is high, because government borrowing when we are at a full or near full employment level will necessarily compete with private investment borrowing and may displace private investment that can increase productivity and the rate of growth of the economy . The key is that in a full employment economy, government borrowing must be taken in light of what private investment borrowing it may be replacing. Government borrowing for infrastructure investment could still be a good thing, but it should be for projects that provide a rate of return to the economy as good or better than the private investment it may be replacing.

Paying off the debt

The reality is that the federal government debt never needs to be paid off, only the interest on it needs to be paid. A fiscally strong nation that can be depended upon to pay its obligations and bills can always refinance its debt, by issuing new bonds to pay off old bonds. This does little harm to a nation whose output capacity (GDP) over the long term is growing faster than its debt, in which case debt as a percentage of its income shrinks, again over the long term.

A government debt that is under control in the sense that its long term growth rate is not faster than its long term growth rate of GDP is a benefit to a capitalist economy. Can you imagine an economy without U.S. government bonds? It is certainly possible. In such a world high grade corporate bonds would probably take the place of government bonds as a safe haven asset. But corporate bonds would be a poor substitute for bonds backed by the full faith and credit of the U.S. government in a vibrant growing U.S. economy. By being a true safe haven asset, government bonds act as a lubricant that helps the economy function smoothly.

As long as the U.S. economy remains strong, the U.S. government debt can be continuously refinanced. The key is that we want our long term rate of GDP growth to be at least equal to the long term rate of growth of our government debt. I say long term because in any one year or short span of years it can be acceptable for the debt to increase more than the growth in GDP, in recessions for example; as long as there are years, primarily when we are in a full employment economy, when the government debt increases by less than GDP.

What we should wish for in a government budget is that it sets the trajectory of U.S .government debt to equal to or below the trajectory of the growth in U.S. gross domestic product.

If we can manage that, we and our children will be in good shape.

References:

Data on the U.S. government debt

https://www.treasurydirect.gov/NP/debt/current

https://www.whitehouse.gov/omb/budget/Historicals

On GDP data

https://www.bea.gov/national/index.htm#gdp

On debt held by foreigners

http://ticdata.treasury.gov/Publish/mfh.txt

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