In light of the intense debate over the “fiscal cliff” – triggered by unsustainable federal budget deficits that are growing the national debt at an alarming rate – this might be a good time to revisit the national debt and put that problem in perspective. Just how bad is it? Who’s on the hook to pay it? What’s the best way to fix it?
Most economists relate the national debt to our gross domestic product, or GDP – in other words, the size of the economy. So let’s begin there. The following shows the growth in our national debt vs. growth in GDP: National Debt vs. GDP, 1929-2012. (Source: U.S. Bureau of Economic Analysis.) Note that the two have grown in tandem but, beginning in the early 1980’s, the national debt began to catch up to GDP and the lines crossed in 2010.
To make it easier to understand, let’s look at the national debt as a percentage of GDP: National Debt as Percentage of Chained GDP. (Source: U.S. Bureau of Economic Analysis) The war effort (World War II) skyrocketed the national debt to 120% of GDP but, once the war ended and federal spending returned to normal levels, growth in the economy steadily outpaced growth in the national debt until the national debt fell to only about 33% of the economy in 1981. Aside from a brief period in the late ’90s, when a bubble in the stock market and in the PC/cell phone/internet businesses generated a ton of federal revenue, resulting in balanced budgets, the national debt has grown steadily as a percentage of GDP, but really began to accelerate in 2008 when the “Great Recession” took hold. Now the national debt exceeds our GDP, a milestone where some economists begin to fret. How much debt is too much? I don’t think anyone really knows. As a percentage of GDP, some nations’ debts are actually much larger than that of the United States. Interest payments on the debt are still a relatively small part of the federal budget, though growing.
But who’s really on the hook for this debt? If holders of America’s bonds decided to cash them in and demand repayment of their principal, where would the money come from? The federal government would have to extract revenue from “the economy” in order to come up with the cash. But that’s misleading. Almost all federal revenue comes from the pockets of individual taxpayers. Any revenue generated by taxing business simply gets rolled into the cost of their products and we still end up paying. So, what’s more significant than the percentage of GDP that the national debt represents is your share of it. How much do you owe? Would you be able to pay it? Here’s a chart of the national debt per capita, and how it’s grown from 1929 to today: National Debt Per Capita, 1929-2012. (Sources: U.S. Bureau of Economic Analysis and U.S. Census Bureau)
Yikes! Now that’s scary! On average, every man, woman and child owes about $44,000 on the national debt – a new record in 2012, and climbing really fast. That’s more than double what it was at the end of World War II. If you’re the breadwinner for a family of four, your family owes $176,000. Could you afford to pay that? Few could. Virtually no one could by having a percentage deducted from their pay in the form of taxes. It’d have to come from your net worth – your home and your savings.
So let’s take a look at household net worth to see just how many people could afford this. This chart shows both the median (the point at which half of the people have higher net worth, and half have lower net worth) and the mean (average) net worth of households: Household Net Worth. (Source: U.S. Federal Reserve) First of all, as an aside, notice that the median net worth hasn’t grown at all since 1983, the year the Federal Reserve first began tracking this data on a triennial basis. But the mean has grown nicely. This means that the net worth of the top few percent of households has grown at a phenomenal rate. In 2010, the median household net worth was about $77,000. But, on average, each household owes $176,000 on the national debt. In other words, if your net worth is anywhere near the median or less, you’re broke! You just don’t know it yet.
In actuality, though, the national debt wouldn’t be spread evenly across all households. The rich would have to shoulder much more of the burden, since their net worth is much higher. So how much would each household owe if the percentage of net worth was the same for everyone? To calculate this, we divide the national debt by the sum total net worth of all households combined. Here’s the chart: National Debt as Percentage of Total Household Net Worth. (Sources: U.S. Bureau of Economic Analysis and U.S. Federal Reserve)
As you can see, this figure held fairly steady for decades in the 12-20% range. But, in 2010 (following a brief period during which if fell, thanks to the bubble in housing market), it jumped to 28%, thanks to a big jump in the national debt and a fairly big drop in household net worth in the wake of the “Great Recession” a few years ago. The point is that, if we’re all to pay an equal amount in terms of percentage, we’ll all be called upon to fork over 28% of our net worth.
What are the odds that all of America’s creditors will want to cash out at the same time? Slim to none. Why would they? They’d be paid in dollars. Then what? What do they do with those dollars which, ultimately, can only be redeemed in the U.S.? Nevertheless, as the debt goes higher, so too does the risk that more and more creditors will become uncomfortable and will want their money back. One way or the other, the debt has to begin coming down at some point, whether it’s done by the government through tax increases and spending cuts, or by creditors cashing out.
In essence, you owe 28% of your net worth to the federal deficit spending that has taken place over the decades, propping up the economy and making us all feel wealthier than we really are. And, bear in mind that the median household net worth hasn’t risen since 1983. Were it not for that deficit spending, most of us would actually be 28% poorer. The unraveling of the national debt process is going to be painful. Even if it occurs over many years, it will be a matter of the federal government withdrawing stimulus from the economy. It’ll leave all of us poorer than we would be if the deficit spending continued – something that can no longer be sustained.
Of course, there is a way that the national debt could be cut painlessly – a way that no politician or economist has dared to address – a way that addresses what necessitated the deficit spending in the first place – and that’s fixing our trade policy to restore a balance of trade. As I’ve discussed many times in the past, it’s no mere coincidence that the growth in our national debt closely tracks the growth in our cumulative trade deficit. You’ll notice that, in all of these charts, things took a turn for the worse in the early 1980s. That coincides closely with the beginning of our string of 37 consecutive annual trade deficits that began in 1976, sapping nearly $12 trillion from our economy. Here’s that chart once again: Cumulative Trade Deficit vs Growth in National Debt. (Source: U.S. Bureau of Economic Analysis)
Without tackling the trade deficit, any meaningful progress toward reducing the national debt is impossible without throwing the nation into recession. Both parties know it. Neither wants to address it. Republicans love our trade policy because it’s in the best interest of their rich, corporate benefactors. Democrats love it too – perhaps not to the same degree – because it makes people more dependent on government largesse. But now both parties are stuck. The most likely action is some token, trivial revenue increases and spending cuts in return for mutual agreement to address the problem in a more meaningful way, perhaps after the next election. And the next time the debt is tackled again? The result will be the same.