Consequences of High National Debt
A couple of weeks back, we saw the U.S. Fed cut rates by 50 basis points. Many analysts believe this is now the start of a series or cycle of rate cuts in the U.S. This means the dollar will be cheaper to borrow and should in theory give riskier assets (like crypto) and store of wealth assets like gold and bitcoin -depending who you ask 🙂 a bump. With that in mind this week I thought I’d look at the U.S national debt and how and why it could affect our trading ideas.
The U.S. national debt refers to the total amount of money that the federal government owes to creditors, both domestic and foreign. It accumulates over time through borrowing to cover budget deficits, where the government’s expenditures exceed its revenues. Here’s a comprehensive overview of the U.S. debt, including how it works, its components, and its implications:
1. Components of the U.S. Debt
A. Public Debt
This is the portion of the debt held by external entities, including individuals, businesses, foreign governments, and other organisations.
It is financed by issuing U.S. Treasury securities such as Treasury bills, notes, and bonds.
B. Intragovernmental Holdings
This represents money that the federal government owes to itself, primarily from trust funds like the Social Security Trust Fund and Medicare.
These funds are invested in U.S. Treasury securities and, in essence, reflect future obligations to beneficiaries.
2. How the U.S. Accumulates Debt
Budget Deficits: When the federal government spends more than it collects in revenue (mainly through taxes), it runs a budget deficit. To cover this shortfall, it borrows money, increasing the national debt.
Issuance of Treasury Securities: The government borrows by issuing Treasury securities, which investors purchase with the understanding they will be paid back with interest. This borrowing funds government operations and programs.
3. Reasons for U.S. Debt Accumulation
Government Spending: This includes spending on defense, healthcare, social security, infrastructure, and interest payments on existing debt.
Economic Stimulus: During recessions, the government often increases spending or cuts taxes to stimulate the economy, which can lead to larger deficits and more borrowing.
Tax Cuts: Reductions in tax rates without corresponding decreases in spending can increase the deficit and, subsequently, the debt.
4. Debt Ceiling
The debt ceiling is a legislative limit on the amount of national debt that can be incurred by the U.S. Treasury. It restricts how much the government is allowed to borrow to meet its existing legal obligations.
Congress must periodically raise the debt ceiling to allow the government to borrow more and meet its obligations. Failure to do so can lead to a government shutdown or, in extreme cases, a default on debt.
5. Consequences of High National Debt
A. Interest Payments
As the debt grows, so do the interest payments. These payments consume a significant portion of the federal budget, limiting the government’s ability to fund other programs.
Rising interest rates can exacerbate this problem, increasing the cost of servicing the debt.
B. Economic Impact
Crowding Out: High levels of government borrowing can lead to higher interest rates for private borrowers, potentially crowding out private investment.
Inflation: Excessive debt could lead to inflationary pressures if the Federal Reserve needs to monetize the debt, although this is debated among economists.
C. National Security and Geopolitical Risks
A large portion of U.S. debt is held by foreign countries, such as China and Japan. While this reflects confidence in U.S. Treasury securities, it also raises concerns about economic leverage and national security implications.
6. Current Trends and Projections
The U.S. national debt has been rising steadily and has surged due to recent events like the COVID-19 pandemic, during which the government increased spending to support the economy.
Long-term projections indicate that without significant policy changes, the debt will continue to grow, driven by rising healthcare costs, aging demographics, and interest payments.
7. Debt-to-GDP Ratio
The debt-to-GDP ratio is a key metric used to assess the sustainability of a country’s debt. It compares the size of the debt to the size of the economy.
A high and growing debt-to-GDP ratio can indicate potential problems with debt sustainability, although the U.S. has a unique position due to the dollar’s status as the world’s reserve currency.
8. Potential Solutions and Debates
Fiscal Responsibility: Advocates argue for reducing deficits through a combination of spending cuts and revenue increases (tax hikes).
Modern Monetary Theory (MMT): Proponents of MMT suggest that countries like the U.S., with sovereign currencies, can sustain higher levels of debt without immediate risk, as long as inflation remains in check.
Entitlement Reforms: Some suggest that reforms to programs like Social Security and Medicare are necessary to ensure long-term fiscal sustainability.
The U.S. national debt is a complex and politically charged issue. While it allows the government to finance operations and support economic stability, especially during downturns, its continued growth poses risks that could impact future economic stability and fiscal policy options.