How Much National Debt is too Much?
The national debt, the topic that has gotten everyone talking about in the last one year, is something of a paradox. The government borrows money by issuing bonds which is purchased by investors both foreign and domestic, and this is called National debt or government debt. And in recent years this has been rising up steadily and in the last one year the US has added about 4 trillion dollars’ worth of debt, and the gross national debt has touched 29 trillion dollars. While some groups of economists are concerned with the rising debt, others argue that it isn’t a cause of concern.
The fear of a great financial crisis resulting from too much debt has existed for decades. For long it was thought that the debt of a country must not be greater than its GDP. So, a correct measure according to many was to calculate the debt to GDP ratio, to measure if the debt was too much for the economy. There was a time when the topic of national debt created huge panic among investors in 2008 when the national debt clock in New York hit 10 trillion dollars. It was feared that this debt is going to come due, and would trigger the next financial crisis. But today it stands at 29 trillion dollars, 130% of its GDP, and nothing has ever happened. The problem is nobody actually knows how much debt is too much debt. After the end of the second world war, Britain’s debt was around 270% of its GDP, and again nothing ever happened. Even today Japan’s debt to GDP ratio stands at 254%.
Debt isn’t a bad thing at all, in fact when governments borrow more, they spend more, and this, in turn, boosts the economy. And the current political system of the United States of America necessitates an increase in debt every single year. People want the economy to do well, and in order to achieve that, governments will have to spend more. If the president decided to spend less, increase taxes, and get the deficit under control, the economy wouldn’t do well, and he would not be reelected the next time. So, till date whichever president had promised to reduce debt, has only gone widening it further.
In America’s history, 1835 was the only year when the national debt stood at zero. The government has always borrowed money, especially in times of war, and depression, and it is going to keep doing that. Many believe that this debt is going to come due on one fine day. But in real terms, debt doesn’t come due on one single day, there are different maturity periods for different bonds, and the fed will have enough time to plan in advance. Therefore, nothing is going to come crashing down suddenly on the supposedly "one fine day". Even if the fed senses that there is the possibility that they will have to default, they would just ask the congress to raise the debt ceiling and would issue more bonds to pay off the interests on previous debts. And since the US is the most creditworthy, these bonds would sell like hotcakes. As for last year, banks have bought bonds at record levels. Though the interest rates were at near historically low levels, banks kept on buying bonds like never before, because they were sitting on big piles of cash, as bank deposits hit record levels. And this record level of buying of bonds from the banks could continue for another few years. With the quantitative easing being done, and more money being printed, combined with the stimulus checks, the economy is now flooded with more cash, and new money. This would reduce borrowing from banks, and increase deposits, and banks would be left with more and more unused chunks of cash. With reduced commercial borrowing, banks would have no option but to buy treasury bonds. So, if the fed senses a possibility of a federal default, it would just issue more bonds, which already have a huge demand in the market. Also, most of the govt debt is owned by American investors and institutions including the federal bank, and only a quarter is held by foreign investors. So, there is no question of debt bondage. Despite there being a 4 trillion dollar increase in the national debt in the last year, the interest payments on that debt have actually decreased. Bond yields have decreased substantially in the past few decades. There is no clear reason why but there are many factors adding up to this. Interest rates on bonds are driven by demand. If the public wants to save more, the govt need not attract them with high-interest rates. Also, the aging population is to be blamed for the low-interest rates on bonds. But nobody has a clear idea of why bond yields are so low. The question of “is debt good or bad” has no clear answer. In one way, the question in itself is a bad one. The question of where the debt has been put to use is a more relevant one. The debt to GDP ratio of a country doesn’t mean much as long as the bond yields are low, and the growth rate of the economy is higher. In fact, the congressional budget office has also ruled out the Debt to GDP ratio as a credible measure for a country’s debt and has said that the debt to GDP ratio had no tipping point at which a crisis becomes imminent. If the debt is utilized to stimulate economic growth and yields better returns than the interest rates on it, then there is absolutely no problem. The focus must be on wisely using it to generate the best economic growth possible. Even if the public debt touched 50 trillion dollars a few years later, the sanctity of the US dollar might be questioned, but the US dollar being US dollar is nearly impossible to be replaced with. The currency that even comes close is the Chinese Yuan, but as the Chinese government isn’t transparent, the Chinese Yuan replacing US dollar is something that we will not see for the next 100 years. Plus, there's something called as psychological value people attribute to something. For example gold, the fact that gold is highly valuable is because people THINK it is precious, it is not because gold is rarely found on earth, and again ever since the gold standard of the US dollar was called off, dollars value wasn't pegged to gold, but it still didn't collapse, it is because of the psychological value it had created over the past few decades. Whenever there is a crisis the US dollar index strengthens, because people all around the world move their money to dollar-backed assets thereby buying more dollars, which would increase the value of a dollar because the demand for the dollar is higher. At times of crisis even if the American economy isn't doing well, the dollar is bound to do well, because people THINK it is stable and buy more dollars, and thereby make it more stable unknowingly in the process of buying more dollars, by increasing the demand for it. The dollar is stable not just because America's economy is bigger, it is because people choose to think that way, and the more they think that way, the more stable the dollar becomes. It's like the more you believe in an illusion the more real it becomes. I am not saying the value of the dollar is an illusion but just explaining how people's minds value different things differently. So the value of the dollar is derived from people's way of thinking to a large extent. Maybe the Chinese economy might outperform the US in a few years, and China might replace the US on many fronts, but at the end of the day, it is difficult to shape the minds of people and replace the dollar in the minds of the people, so the dollar is definitely gonna be the most stable currency for a very long time. As long as the US dollar maintains its stature, the United States of America would remain creditworthy, and its bonds would sell. And if there is a huge demand for US govt bonds, interest rates would be lower, making it easier to borrow and repay them. The US falling into a debt crisis? This seems to be a fantasy for sure.