At the end of the 19th century Alexander Hamilton wrote “the national debt, if not excessive, will be a national blessing to us”. A nice idea in theory, but American governments have not stuck to the plan since.
Instead, the American economy is based on a public debt that exceeds 34 trillion dollars, with a debt/GDP ratio of approximately 120%. Perhaps not the blessing the Founding Fathers once envisioned.
Alarm bells are now starting to ring with increasing frequency and volume.
Jamie Dimon says Washington is facing a global market “rebellion” over the bill it is racking up, while Bank of America CEO Brian Moynihan believes it’s time to stop admiring the problem and instead do something about it.
Somewhere else The black Swan Author Nassim Taleb says the economy is in a “death spiral,” while Fed Chair Jerome Powell says it’s time to have an “adult conversation” about fiscal responsibility.
And while it’s “the most predictable crisis we’ve ever had,” according to former House Speaker Paul Ryan — a summary Dimon agrees with — it’s a topic that’s not yet at the top of the political agenda.
It’s also worth noting that it’s not one guy or the other’s job to fix this problem: This debt has been accumulated thanks to spending by both Republicans and Democrats.
The list of presidents who added the most debt by percentage starts with FDR (Dem.), followed by Woodrow Wilson (Dem.) and Ronald Reagan (Rep.).
Whoever it turns to, it’s clear that the public now wants action.
Last year Pew Research found that “reducing government debt” was a top concern for 57% of 5,152 people surveyed, up from 45% just a year earlier.
But should individuals – who currently have a sum of more than $100,000 on their heads when the debt is divided per capita – be so concerned about the issue?
What impact will it have on your purse strings, cost of living and savings plans?
How big is the threat?
It depends on who you ask.
If you’re talking to the Peter G. Peterson Foundation, the problem is quite considerable.
The New York-based nonpartisan organization is dedicated to raising public awareness of fiscal challenges, and rising government debt is one of its top concerns.
The group believes that the debt could lead to a reduction in government spending, a loss of confidence of private investors in the American economy, an increasingly narrow window of prosperity for American families thanks to worsening housing markets and jobs, and a threat to national security.
Laura Veldkamp, a finance professor at Columbia University, takes a less catastrophic view.
Encourage audiences to use real-world comparisons to understand the context around headline-grabbing figures.
Professor Veldkamp explained Fortune: “If the United States were a family, we could measure its debt by debt-to-income ratio. The debt is approximately 1.3 times the national income (GDP).
“Annual interest payments on federal debt amount to about 4% of the debt. This means that the US government has to pay about 5.2% of GDP in interest expenses.
“Federal tax revenues represent approximately 18% of GDP. So, debt payments are less than a third of income. If it were a family or a company, we wouldn’t call it highly indebted.”
The much more difficult question is whether or not this debt is being accumulated responsibly and will result in a positive return in the future.
This is where JPMorgan chief Dimon worries: In a slowing economy, can the government expect to see increased production to offset investment?
“Instead of focusing on the level of debt, we should ask ourselves: what is the return on investment?” Professor Veldkamp added. “If the government issues debt to invest in high-return projects, then debt is good. Otherwise, it will be difficult to repay the debt due to low future productivity.”
It’s inside The myth of the deficitStephanie Kelton, an economics professor at Stony Brook University, points out that government debt has made economies more equitable and prosperous in the past, but that scary words like “deficit” cause companies not to push fiscal support far enough to actually pay. turned off on a large scale.
While Professor Kelton’s belief is a far cry from the apocalyptic views of some, she also does not advocate unlimited spending without cause or future social return, as investing in areas of the economy that already work well simply results in inflation.
Could the real estate market be affected?
Housing, construction, autos and any other interest rate-sensitive sectors will be hit “disproportionately” by the effort to rebalance government debt, said William G. Gale of the Brookings Institute Fortune.
“Higher government debt will tend to raise interest rates,” the author of Fiscal Therapy: Curing America’s Debt Addiction and Investing in the Future She said.
“If the government creates debt, it must be financed somehow: taxes or money creation. If debt gets out of hand, money creation has historically been the (false) solution since it is easier to issue money than raise taxes, but often more disastrous in the long run.”
Any rise in interest rates will shock younger generations climbing the property ladder in the coming decades.
While many economists point out that the Fed’s controversial rate hikes of the 2020s are simply normalizing rates from many previous eras, homeowners and prospective buyers have become accustomed to a federal base rate effectively below 1%.
In addition to having a negative psychological impact, rising rates are also bad news for an already unattainable market.
According to the latest index from the National Realtors’ Association, the median household income is $99,432, while the average amount needed to qualify to purchase a home is $105,504.
Will government debt impact America’s national security?
This is a long-standing fear of industry experts.
More than a decade ago, when the national debt stood at just $19 trillion, former U.S. Chief of Staff Admiral Michael Mullen said the debt was the primary threat to national security.
Fourteen years later, former President Ryan told the Bipartisan Policy Center in January that before long the government will be spending more on debt service than on investments in the Pentagon.
Dimon added: “This is about the safety of the world. We need a stronger military, we need a stronger America. We need it now. So I think this is a risky thing for all of us.”
Couldn’t the government just keep spending?
If the government has accumulated this level of debt and the economy continues to survive – after all, inflation is down, jobs are stable, consumers are in “decent shape” – some may wonder why politicians don’t they can continue to spend seemingly without confidence.
There are a couple of problems with this.
The first is well known: the government has a self-imposed debt ceiling above which it cannot spend, and it needs congressional approval to raise or extend it.
This is a fairly regular occurrence – it has happened 78 times since 1960 – however, negotiations came at the eleventh hour last summer, when Republicans pressured President Biden’s government to promise to rein in spending.
When the issue comes up again soon after the 2024 election, a deal could be more difficult.
The other problem is that, at some point, investors may no longer want to buy government debt if they fear that the government will not be able to repay it.
This is a primary concern for Joao Gomes, senior vice dean for research and professor of finance at the Wharton School of the University of Pennsylvania.
“To me the most important thing for people to keep in mind about debt is that you need someone to buy it,” Gomes said Fortune. “Before we could count on China, Japanese investors and the Fed [buy the debt.] All those players are slowly leaving and now they are selling.”
America’s ability to pay its debts is a concern for nations around the world that own a $7.6 trillion share of the funds.
The most exposed nations are Japan, which held $1.1 trillion as of November 2023, China ($782 billion), the United Kingdom ($716 billion), Luxembourg ($371 billion) and Canada ($321 billion).
“If at some point these people who have so far been happy to buy government debt from major economies decide, ‘You know what, I’m not so sure this is a good investment anymore, I’m going to ask for a higher rate.’ to be convinced to keep it, then we could have a real accident on our hands,” Gomes said.
He added: “The moment the government of any country realizes that it cannot sell $1.7 trillion [annual] debt, it will be necessary to impose major cuts on some programs. This opens a Pandora’s box of social unrest that I don’t think anyone wants to think about.