As debate over further economic stimulus drags on, one theme for reigning in stimulus spending is the high level of government debt. For example, many lawmakers would like to cap the proposed next stimulus package at a trillion dollars to manage concerns about excessive national debt. The credit-rating agency Fitch last Friday warned that the U.S. could lose its triple A credit rating if the U.S. government debt is not managed effectively over the coming years.
The Historical Perspective
One way to examine government debt is relative to a countries Gross Domestic Product (GDP) this compares a country’s debt to the total value of what it produces in a year. On this score, U.S. debt was rising sharply even before the Covid-19 crisis. Debt to GDP rose to 50% by the start of the 1990s, hit 90% coming out of the 2008 recession and hasn’t stopped rising since. Before Covid-19 hit, U.S. debt was estimated at 109% of GDP. It’s much higher now, GDP has declined and stimulus measures are around $3 trillion or so, with potentially more to come. That suggests debt to GDP could move over 130% in the U.S. by 2021 on Fitch’s estimates. That’s more than triple where the U.S. was in the 1970s and 1980s when the metric was closer to 40%.
Time To Worry?
While high government debt may seem a problem, there are other factors to consider. The first is how incredibly low interest rates are now. The U.S. government can currently borrow money for 30 years at under 1.5%. Therefore, even though the amount of debt is high, it’s relatively easy to service. Recall that debt to GDP is triple what it was in 1980, back then rates on 10-year government bonds were 11%. Those interest rates are order of magnitude higher than today. So yes, debt is high, but it’s far easier to service that debt with incredibly low interest rates. That said, inflation and interest rates can change quicker than many expect.
The economic power of the U.S. is clearly helpful when it comes to debt. Many countries use the dollar as a de facto currency. The U.S. has the advantage that its currency is broadly used and well respected. That provides it with greater financial latitude than other countries, to the extent that the U.S. can print dollars, and dollars are coveted. That can change over time of course. Yet, for now the America’s economic position is helpful when it comes to managing debt.
The International Perspective
While a level of debt to GDP of over 100% might be relatively new to the U.S. it’s something Japan blew past in the mid 1990s and debt to GDP in Japan now stands at over 200%. The Japanese experience is somewhat unique of course. Japan has had its share of economic problems, but managing government debt hasn’t been the main concern. Nonetheless, though Japan has been able to manage a high debt load, it’s up there with Venezuela and Sudan in terms of debt to GDP. Those cases inspire less optimism. Still Japan shows that there isn’t an obvious level above which debt becomes unsustainable, or at least Japan hasn’t seen it yet.
Debt isn’t a problem until it is. Then it can become overwhelming. The recent weakness in the U.S. dollar, albeit after a run up in the early days of the crisis in March and the strength of physical assets such as gold suggest some concerns for the dollar as debt has increased given the vast stimulus response to Covid-19. However, for now, these are just near-term trading movements,
The U.S. dollar is such a pivotal component of the financial system that any shifting tide will take years, perhaps decades. However, the current direction of U.S. debt, if sustained, does not inspire long-term confidence, and the rating agencies and financial markets are starting to take notice. For now, this U.S. debt not a concern, but should it ever become one, the consequences would be dire. The U.S. is edging a little closer to that scenario.