Debt: An American Obsession
America is suffering from the disease of misguided rhetoric. Common though this ailment is, in certain circumstances it has a more damaging effect than in others. The economy – the most vital organ in a country – is being choked because of anti-national-debt rhetoric and sentiments. Many Americans view public debt as toxic – a financial element that needs to be avoided at all costs. In reality, as Alexander Hamilton, the first Secretary of the Treasury, stated, “national debt, if it is not excessive, will be…a national blessing” that can boost the economy, create jobs, wealth, and lower debt in the long run. Given the current economic malaise, the purveying anti-debt sentiment is actually preventing a return to high employment rates, high labor participation, and respectable GDP growth. The fixation with the level of debt is detrimental to the American economy because it prevents certain stimulatory actions from being implemented – actions that would boost aggregate demand and GDP, creating jobs and wealth. American debt is not, as many Americans and politicians believe, yet at a dangerous point, as evidenced by the market’s faith in America’s ability to repay debt, a public debt to GDP ratio that is far from a historical worst, and a relatively and economically safe public debt to GDP ratio. The dangerous anti-debt feelings are the fault of the media, whose indexing model cause politicians ignorant debt statements to become widespread and not subject to challenges by another school of thought. America, indeed, has a flawed fascination with lowering the national debt when the general populace – as well as politicians – need to realize that our debt is not so bad as rhetoric suggests, that Keynesian economic principles that will expand the debt in the short run need to be implemented, the austerity measures rampantly chased and endorsed by conservatives does not work, and the media needs to change its framing of the national debt – which, due to indexing, will likely only occur if politicians once again begin to view debt as a tool by which a booming economy can be created.
As America plunged into the throes of the Great Recession, suffering tens of millions of lost jobs and financial agony, the political response to the plight of everyday Americans was to focus on job creation. Not just job creation, but job creation whatever the cost may be to the federal checkbook. That sentiment led to the 2009 passage of an $800 billion stimulus bill (the American Recovery and Reinvestment Act), which succeeded in stopping the hemorrhage of job loss and creating around 2 million jobs (Cohen). However, despite its successes, the reaction to the stimulus was largely negative because unemployment remained at a startling 10% (Leonhardt), and instead of focusing on the objective flaws of the stimulus (which revolved around its size, an amount that was too small to combat the depth of the financial crisis), Republicans and the emerging Tea Party seized voters’ anger caused by high unemployment, channeled that anger into an electoral victory, and began to push forward austerity measures which claimed to reduce the deficit and debt while creating jobs. The midterm elections of 2010 and resulting Republican takeover of the House and gains in the Senate caused the rhetoric and political actions of Washington to shift from job creation at all costs to a flawed fixation with curbing runaway deficits and lowering the national debt.
Even before the midterm elections, President Barack Obama gave credit to the Republicans’ political agenda, stating in the 2010 State of the Union address that “if we do not take meaningful steps to rein in our debt, it could damage our markets, increase the cost of borrowing, and jeopardize our recovery” (Sahadi). This change in rhetoric – from job creation and growth to a focus on taming the debt – was quickly echoed throughout the media, building a grassroots hatred of debt – a sentiment from which the Republicans would easily and happily draw in the midterm elections. Following Lance Bennett’s principle of “indexing”, which states that the media tends to echo issues advanced by politicians and the media focuses on the sides argued by opposing politicians, even if those positions have no basis in fact – the media’s reporting of debt dramatically increased immediately following the State of the Union address and once again during the run up to midterm elections. The combination of increased news reporting and changing political rhetoric was primarily responsible for the widespread anti-debt sentiments, however economically dangerous though those feelings are.
A primary concern of those worried about the national debt is the borrowing cost for the United States (Bivens and Irons). It is argued, correctly, that should a country appear insolvent to investors, occurring when investors feel that a country has no possible way of paying back debt obligations and will thus default on loans, interest rates will rise on government-issued bonds because investors will want a greater reward for risking their money, an occurrence that fits within the definition of capital flight (McLeod). When interest rates on bonds becomes too high, it is extremely difficult for a country to raise money because future interest payments will be large and contribute to deficits and future debt. Essentially, it becomes too expensive for a country to borrow money. This has happened recently to European countries such as Greece, Ireland, and Portugal. Those three countries faced abhorrent interest rates on 10-year bonds (the primary measurement of investor faith in a nation) and couldn’t raise money; instead, they relied on loans and bailouts from the Troika (the European Central Bank, the International Monetary Fund, and the European Commission). Fiscal conservatives – those who advocate lessening government spending in order to bring down deficits and the national debt – rightly don’t want America to follow in the footsteps of the financially doomed European countries. But if we let the market speak, we are not in any danger of that happening – after all, as prominent fiscal conservative Milton Friedman said, “If an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it.”
Interest rates on 10-year Treasury bills are near historic lows and have been for quite some time, with inflation-adjusted bonds actually carrying a negative interest rate for parts of 2013. This means that investors were paying the US government to hold onto their money. Clearly, investors have faith that the federal government will be able to pay back its dues and is in no immediate threat of becoming insolvent.
Figure 1: Interest rates on the 10-year Treasury bill from 2010 to November, 2013. Source: Yahoo! Finance
As seen by the above chart, the general trend for the interest rate on the 10-year T-Bill has been for it to fall; in fact, since the first week of 2010, the interest rate has fallen almost 29%. The current rise in interest rates has nothing to do with debt levels, but rather the combined effects of a government shutdown, a near breach of the debt ceiling (which would have left the United States unable to repay short-term debt obligations), and a strong stock market rally, encouraging investors to pull money from low-yielding bonds and instead purchase stocks whose potential for high returns is greater. Furthermore, the current interest rate (2.80% at the time of this writing) is well below the 6.77% average yield of the 10-year T-Bill between 1962 and 2012 (based on data from the Federal Reserve). Letting the market speak – as so many fiscal conservatives scream to let happen – simply bolsters the argument that debt is not yet spooking investors: Based on interest rates, investors are more confident in the safety of the United States government’s long term debt obligations than ever before.
When the national debt reached $16 trillion, fiscal conservatives, Republicans, and even some Democrats threw a fit, zeroing in on the number – out of context – to advocate austerity policies. While the number – $16 trillion – is undoubtedly frightful, it is not “too overwhelming to comprehend” (Perry). When put in context, the amount of debt looks much more manageable and even ceases to be an immediate worry, opening the door for discussions about further expansionary policies.
Yes, the US national debt is large, but so is the US economy. To put the national debt into context, one must examine the ratio of the debt held by the public to the gross domestic product (GDP). Economists care about the debt held by the public and not the gross amount of debt because debt owned by the government (for example, in the Social Security trust fund) “does not affect credit markets” (Kogan, et al). Debt held by the public “affects the economy” and “[t]he borrowing associated with that debt competes for capital with investment needs in the private sector…and can affect interest rates” (Kogan, et al). Thus, to create an apt measure of debt that affects credit markets in relation to the size of the economy, economists use the public debt to GDP ratio (PD/GDP). The chart below shows the US debt held by the public as a ratio of GDP throughout the history of the country.
Figure 2: US public debt as a ratio to GDP. Source: The Atlantic
Historically, the United States’ PD/GDP is not at a high – far from it. During the Second World War, the government ran massive deficits and raked up a high debt in order to purchase the necessary military goods. While this contributed to debt, it also created a booming economy that helped the nation recover from the Great Depression and from which decades of prosperity were born. While there is no world war, or total war, for that matter, on which the government can spend money, the same idea of deficit spending would sow the seeds of an economic boom.
In addition to the PD/GDP ratio not being historically bad or dangerous, the United States’ PD/GDP is lower than that of other countries. Germany’s estimated PD/GDP ratio for 2012 is 81.9%; the United Kingdom, 90%; France, 90.2%; Japan, 214.3%. By comparison, that of the United States for 2012 was 72.5%. In relation to these other G-5 countries, the United States is in solid financial standing with regards to PD/GDP, a story that is rarely told. Even Japan, with a PD/GDP of twice its economy, is experiencing near-record low rates on its 10-year treasuries. The same can be said of Germany. Bond vigilantes, “investors who dump a country’s bonds – driving up its borrowing costs – when they lose confidence in its monetary and/or fiscal policies” (Krugman), have yet to attack any of the countries in a worse fiscal position than the United States, suggesting that should the United States’ PD/GDP rise, the country will be on firm financial standing.
Another issue with which conservatives like to threaten the country with is the inevitable difficulty in paying off the national debt. They are right – it would be extremely difficult to pay off over $16 trillion without substantial damage to the economy and years of austerity measures. That being said, the national debt need not ever be paid off entirely, or at all. Debt can continue to grow as long as its rate of growth is less than the rate of GDP growth. Paul Krugman highlights the trivial example in his book End This Depression Now!: The quickest way to lower PD/GDP would be to keep the real value of the debt constant, achievable if the United States were to pay “the value of debt multiplied by the real rate of interest” (Krugman). Using a real interest rate of 2.5% (around the real interest rate prior to the financial crisis) and multiplying it by the debt held by the public, approximately $12 trillion, results in interest payments of $311 billion per annum to keep the real value of debt constant. While that is a substantial amount, it is only 1.94% of a $16 trillion economy. The United States would be put under minimal financial duress to keep the real value of debt constant. As the economy naturally expands, the PD/GDP will fall. The above example highlights the quickest means of lowering PD/GDP; the ratio will fall no matter what as long as real debt growth is lower than real economic growth.
Accepting, now, that debt is not an immediate problem, the conversation ought to turn to creating policies that will promote full employment and economic growth. That, however, has not been done as austerity measures are all the fashion in Washington. Lord John Maynard Keynes stated it best: “the boom, not the slump, is the right time for austerity at the Treasury.” This is due to the fundamental equation in macroeconomics, which says that GDP is equal to consumer spending (C) plus government spending (G) plus investment (I) plus net exports (NX). Austerity measures decrease government spending, obviously lowering the value of GDP. Fiscal conservatives argue that austerity, which includes decreasing government spending, will lead to an increase in consumer confidence and investment (Aslund). Not so. In an economic decline, consumer spending will remain depressed and as long as unemployment remains high, consumer spending will not increase enough to offset a reduction in government spending. Also, investment will not rise because investors will be hesitant about private investment (money going to business allowing them to upgrade infrastructure, etc). Since consumer spending will be muted, there is little potential for increased profits – or even for profits – making an investment into a company rather risky. Hence, many investors will flood the government bond market seeking safe, albeit slimmer, returns. Now that austerity during the slump has been debunked, a quick examination of the below figure explains why expansionary fiscal policy (i.e., a stimulus) is beneficial to the overall economy.
Figure 3: Expanding aggregate demand. Source: http://www.bized.co.uk/sites/bized/files/images/cladinc.gif
Expanding the aggregate demand, which is equal to the GDP, also makes the GDP greater and boosts employment (Blinder). Given the components of the GDP, and also employment, it is vital to increase recessionary spending to combat the decline in investment and consumer spending, something that can only be done by the government. Those opposed to government spending will turn to the increase of price levels (inflation) caused by said increase of government spending. Though on the surface inflation may appear to be bad, in moderate amounts it actually aids a recovery.
According to Paul Krugman, one of the main problems facing consumers after the Great Recession was private debt. During the boom of 2000s families piled on debt with levels often times higher than incomes. Consumer spending stalled because as people slowly returned to work, wages were used to pay interest rather than to purchase consumer goods. Here’s where inflation comes in. Inflation benefits debtors; it decreases the value of money so after a period of time, say 15 years, the initial amount borrowed is worth less than it was at the time of borrowing. Assuming wage growth keeps up with inflation, consumers will spend a smaller proportion of their income on interest each ensuing year. Therefore, as inflation rises, the burden of debt diminishes and consumers will begin to have the financial means to buy other goods, thereby increasing GDP and allowing the government to curtail spending, which would rein in inflation growth. For all the bad press it gets, some inflation is actually helpful.
Perhaps the biggest impediment to successful implementation of Keynesian economic policies is the accrual of debt that accompanies deficit spending. The actual amount needed to correct a recession is dependent upon the multiplier effect, the expansion of a country’s money supply because of banking (Investopedia), and Okun’s law, which describes the relationship between changes in unemployment and changes in GDP (Okun); but large deficits would be needed, which ultimately will add to national debt. However, the effects of a Keynesian-style expansion ought to be remembered: higher employment, inflation, and GDP growth. These three elements combined, in the long run, work to erase the added debt.
A contributing factor to the accumulation of debt during a recession is the diminishing of the tax base as consumers become unemployed or encounter lower wages. Higher employment has the opposite effect – it widens the tax base, meaning more tax revenue can be collected and the government will have more funds with which to pay interest on debt. Inflation, too, plays an important role when coupled with a larger tax base. As prices rise, wages also rise (ideally in tandem). Higher wages equates to more taxable income across a wider tax base yielding higher government revenue compared to before the recession. GDP helps lower the burden of debt by the aforementioned statement that GDP growing more quickly than debt lowers the PD/GDP ratio and eases the stress of debt. Together, higher employment, inflation, and GDP growth leave a country in a better financial position than before a recession and in a much better position than if austerity measures were implemented.
The purveyance and anti-debt sentiment can be traced back to 2009, beginning with President Obama’s State of the Union address and continuing with the rise of the Tea Party. While the movement has many vocal supporters – whose numerous, and frankly ridiculous, statements and dramatic rhetoric on the subject translated into increased media coverage and the dissipation of beliefs – the national debt of the United States is decidedly a non-issue. The market has stated that it does not believe the United States is at risk of failing to pay obligations, as evidenced by persistently low interest rates on treasury bills. Moreover, the PD/GDP ratio – the amount of debt held by the public divided by the gross domestic product – is neither near record highs nor as bad as other G-5 countries, all of whom are also experiencing near-record low interest rates. The United States’ PD/GDP of around 75% is well below the 90% threshold that many economists believe to be dangerous for economic growth (Kogan, et al). Even another stimulus will not bring the country to that level and if it does, the positive effects of the stimulus will quickly lower the PD/GDP. The benefits of adopting Keynesian-style expansionary policies far outweigh the costs of an immediate increase to debt. Boosting government spending via deficit spending and borrowing will lead to an increase of aggregate demand, raising employment, wages, and GDP, allowing the United States to enter a virtuous cycle of economic growth. Once consumer spending returns to levels capable of driving the economy, the government can implement slight austerity measures to contain a hot economy and to pay down debt.
Debt levels are hefty, but they never need to be repaid. The burden of debt will be eased as long as GDP growth is greater than the growth of publicly-held debt. This means deficits need to be a smaller proportion of the total publicly-held debt than the rate of GDP growth. During a fiscal expansions this will not be the case, but once the economy has recovered due to expansionary policies, deficits can be curtailed and GDP growth will be high. Over time, the PD/GDP ratio will fall and even fiscal conservatives will not be able to use debt as a means by which to win elections.
The above suggestions currently feel unfeasible because of the political and popular climate towards debt. Again, this can be changed either by vocal progressive politicians or by a change of the media. Either will provide the spark needed to burn the incessant and erroneous debt beliefs.
Debt is a tool and must be viewed as such. Without utilizing all financial weapons, the country will inevitably be doomed to years of minimal growth, high unemployment, and low labor force participation. To quote Larry Summers, the Treasury Secretary during parts of the Clinton administration, “[w]e averted Depression by acting decisively in 2008 and 2009. Now we can avert a lost decade by recognizing current economic reality.”