Senate bill would add at least $3.3 trillion to the national debt, according to the Congressional Budget Office.
That was the headline in the New York Times as the Senate debated Donald Trump’s Big, Beautiful Bill, an obese and odious tome at 1000 pages. The numbers associated with the deficit and debt have gotten so large that the headline, despite being multi-trillions of dollars, is just a small fraction of the debt we’ll incur over the next decade. The $3.3 trillion is the amount the bill increases the debt, above and beyond the $21 trillion that was already in the pipeline for the next 10 years.
I read just about every day about how this huge and mounting debt is a scandal of epic proportions, that it will lead to higher interest rates, lower growth, higher inflation, reduced investment and ultimately a financial crisis. It may also cause shingles and the heartbreak of psoriasis. Political operatives of all stripes, from the far left to the far right believe this is a calamity waiting to happen. I’ve been waiting for 40 years.
I first started reading about the potential for a debt induced financial crisis in the early 80s when Ronald Reagan’s tax cuts and defense spending led to, at the time, unprecedented peace time deficits. The national debt rose from 25% of GDP when he entered office to 38% when he left.
All that extra debt – at rates a lot higher than today – that the deficit scolds said would lead to a return of that 70s malady called stagflation, and instead interest rates peaked early in his first term and fell for the rest of his time in office. Following the passage of Reagan’s Tax Act of 1981 real GDP averaged nearly 4% growth and the inflation rate fell by half.
We had rising inflation and interest rates throughout the 1970s and the debt/gdp ratio never exceeded 27%. We had falling inflation and interest rates in the 1980s and 90s while the debt ratio was nearly doubling. Since 2008 the debt ratio has risen from 35% to 103% at the onset of COVID, while inflation, even including the recent bout of rising prices, averaged less than 2%/year. Interest rates, growth and inflation are not correlated with annual deficits or the national debt.
The debate over government debt has always centered around its value as a percent of GDP. Why is this the chosen metric? It is a measure of the accumulated debt as a percent of annual domestic output (which is also domestic income), but why is that the important metric?
That isn’t what we use to measure creditworthiness of any other entity. If a couple applies for a mortgage, their assets will be taken into account but the most important measures are their work history and their income relative to their debt payments, not their total debt. A couple with no other debt that takes out a $500,000 mortgage would need an income of about $160,000 to qualify. The ratio of their debt payments to income would be 28% (monthly mortgage payment of $3730 based on national averages and gross monthly income of $13,321). But their “Debt/GDP ratio” (total debt to income ratio) would be 312.5%. No one would think this couple is on the verge of bankruptcy.
The same is true of corporations. Apple has total long term debt of $98.2 billion and TTM net income of $97.3 billion, a ratio very similar to the US debt/gdp ratio. Eli Lilly’s debt/income ratio is a horrifying 350%, Netflix 161%, Walmart 245%, Proctor & Gamble 220% and Home Depot 358%. I don’t remember anyone fretting that the bluest chip companies in the country are on the verge of bankruptcy. And neither is the United States.
What matters is our ability to service our debt, not its size relative to one year’s output. Current Federal expenditures on interest payments are 3.7% of GDP, slightly above the average of 3.1% since 1947. Markets are a discounting mechanism and if investors believed we couldn’t or wouldn’t pay our debts in the future, they would demand higher interest rates today. Logically what a bond investor fears is not a high debt/gdp ratio today but a lack of growth tomorrow.
The 1970s were an awful time for America, a decade marked by high interest rates, high inflation, gas lines, leisure suits, disco and Ford Pintos. But as I said above, the high interest rates of the 70s had nothing to do with our debt burden at the time. High interest rates were a result of investors' lack of faith in our future.
On July 15th, 1979, Jimmy Carter addressed a demoralized nation to deliver what became known as the “Malaise” speech. Americans were disillusioned with politics and felt helpless against the forces shaping their lives. Jimmy Carter got a lot wrong in his presidency but this one sentence captured the essence of what was wrong with the 70s:
“The erosion of our confidence in the future is threatening to destroy the social and the political fabric of America.”
The debt debate is political not economic, Democrats and Republicans alike using it to score cheap political points with their supporters. It hasn’t mattered because the US economy is the most productive and innovative in the world with an almost unlimited capacity for growth.
It is that future growth that investors are focused on today and why, despite the fear mongering about our debt, we are able to borrow at such low rates. That will remain true as long as we trust in the American spirit to take risks, compete and succeed. The debt will only become a burden if we repeat past mistakes, if we kill the confidence that produced the greatest economy in the world.
