Understanding the U.S. National Debt Crisis
Is the U.S. national debt a real crisis? Does it possess the destructive power of a natural disaster like a hurricane, tornado, or earthquake? The short answer is yes, but the full explanation requires a financial history lesson.
The Good and Bad of Debt
The first point to understand is that debt can be good or bad. The decision depends on two criteria: the cost of the debt relative to the returns that can be gained from investing it wisely, and the size of the debt relative to the income available to repay it or roll it over.
For instance, if a government borrows for 10 years at an interest rate of 4.0% and builds infrastructure that will produce economic gains of 10.0% or more for an indefinite period of time, that’s a good use of borrowed money. However, money borrowed to finance non-productive projects or to give handouts is plainly wasteful.
The Current State of U.S. National Debt
The U.S. national debt today is approximately $35.7 trillion. This figure only accounts for Treasury debt and does not include contingent liabilities for unpaid student loans, Social Security, Medicare, mortgage guarantees, unfunded FDIC insurance liabilities, and more. Whether this is a big number or not depends on the income available to pay it off.
A good proxy for national income is the gross domestic product (GDP). By expressing the national debt as a percentage of GDP, you can get a good idea of whether the debt is excessive. Economists agree that a 30% debt-to-GDP ratio is entirely comfortable. However, as the debt-to-GDP ratio climbs, two adverse conditions result. The first is that the return on investment declines.
The Point of No Return(s)
Research indicates that a debt-to-GDP ratio of 90% is a threshold. This is the point at which the return of each dollar borrowed and spent is less than $1.00. This means that not only do you not get your dollar back, you add more to the numerator (debt) than you do to the denominator (GDP), which makes the ratio even worse and lowers the return on the next dollar borrowed and spent.
The current national debt of the United States is $35.7 trillion. GDP is estimated at $28.7 trillion. This produces a debt-to-GDP ratio of 124%, the highest in U.S. history. This ratio is well above the 90% red line and is getting worse by the minute as U.S. deficit spending skyrockets while growth stalls. The U.S. debt-to-GDP ratio will soon be pushing toward 130% and higher. That’s a level reached by failed states like Lebanon and super-debtors like Greece.
Historical Perspective on U.S. National Debt
The U.S. did not begin as a debt-free nation under George Washington in 1789. It agreed to assume the Revolutionary War debt of the individual states and the Continental Congress instead of allowing that debt to go into default. Alexander Hamilton's insight was that the U.S. could borrow more money through the U.S. Treasury to pay off the war debt, establishing the U.S. as a good credit and enabling the country to keep borrowing.
The national debt (adjusted for inflation and expressed as a percentage of GDP) has moved in more of a sine wave than a straight line. That wave corresponds to the fact that debt goes up in times of war and is then reduced in times of peace. This pattern of increasing debt to fight wars then decreasing debt during times of peace was remarkably consistent for most of American history.
The Current Debt Crisis
The U.S. had lost its ability to win wars and lost the will to reduce spending in times of peace. The debt-to-GDP ratio was now a steeply pitched slope instead of a gently curved sine wave.
There’s no need for default because we can always print the money. There’s no way to grow out of it because the high debt ratio inhibits real growth. The only solution is high inflation where the nominal debt may go up, but the real value of the debt shrinks dramatically. Unfortunately, the value of your stock portfolio will shrink dramatically as well.
The remedy for this crisis and threat to your wealth and well-being is a portfolio of inflation-proof assets including land, gold, silver, fine art, natural resources, and some cash for liquidity and bargain hunting when the time comes.
Bottom Line
The U.S. national debt crisis is a complex issue with deep historical roots and significant potential consequences. It's clear that the current debt-to-GDP ratio is unsustainable, but the solutions are not straightforward. What are your thoughts on this issue? Do you agree with the proposed solutions? Share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.
