The United States Debt Keeps Growing – How Will it be Paid Off?
Annual U.S. deficits may have shrunk in recent years, but the overall U.S. deficit and amount of unfunded liabilities has not. The U.S. deficit is estimated to be $19 trillion and estimates on unfunded liabilities start around the $100 trillion mark. A common reaction to rising levels of U.S. debt is that there are other countries with higher debt to GDP ratios than the United States and that the ratio has been higher in the past (e.g. after World War II). For starters, ‘everyone else is doing it’ or doing it worse has never been a valid excuse for a child’s bad behavior and it certainly isn’t justification for a government’s reckless borrowing and spending habits.
Secondly, GDP doesn’t pay debts, taxes do. At current level of debt and unfunded liabilities, taxes can never cover the total amounts owed. The way the U.S. has financed its deficits is simply by kicking the can down the road, keeping interest rates low (but higher than most countries) and issuing more bonds for which there is a large and ready domestic and international appetite.
Enter the King of Debt, Donald Trump
Over the past two weeks Donald Trump has weighed in on the U.S. debt issue. Mr. Trump has suggested, echoing former Federal Reserve Chairman Alan Greenspan, that the United States can pay off its debt by “printing money”. Mr. Trump, however, recognized that this approach would cause price inflation and the need to raise interest rates and make the ability to pay the interest even more difficult on a mounting pile of debt. Donald Trump also intimated that he would consider “renegotiating” the terms of U.S. debt, which some interpreted as paying less than full value on the amounts owed, in effect a partial default on U.S. Treasuries. Mr. Trump later walked back his comments without properly qualifying them saying that he meant the U.S. could ‘restructure’ its debt without defaulting and that it was ‘crazy’ to think that he would advocate a default on U.S. Treasuries.
The Reaction
The financial media attacked Mr. Trump’s comments as irresponsible. How dare he suggest that the United States, the most powerful country in the world, with the strongest economy, default on its bonds or simply ‘print the difference’? Some considered Mr. Trump’s statements as adding to potential instability in an already fragile world economy. Missing in the outrage directed at Mr. Trump’s debt musings was an objective view of the U.S. debt situation. How indeed, can the U.S. pay off its debt and meet its unfunded liabilities? Mr. Trump’s off hand solutions were considered untenable, yet the U.S. debt situation itself is untenable, so any workable solution would appear to be as well.
Trump’s observations on the U.S. debt situation only serve to refocus U.S. Treasury Bond holders on the burgeoning U.S. debt situation. Foreigners hold over $4 trillion in U.S. Treasuries and most are acutely aware of the U.S. financial situation and didn’t need Mr. Trump’s observations to understand it. The launching of a six year quantitative easing program by the Federal Reserve in 2009, whereby the Fed printed over $4 trillion and purchased $2.5 trillion worth of U.S. Treasury Bonds with it, drew attention to the printing option and it’s no secret as to the status of the U.S. deficit. China, the largest U.S. foreign creditor with over $1.3 trillion in U.S. Treasury bond holdings, has openly complained about U.S. fiscal and monetary policies.
Potential Solutions to the U.S. Debt Problem
Here are a few of the solutions to the U.S. debt problem:
Monetary policy options
- Kick the can down the road by issuing more bonds and use the proceeds to pay existing obligations and hope there is a market big enough to absorb the additional debt issuances.
- Keep interest rates low or make them negative to reduce or eliminate cost of borrowing.
The two options above are the current ones being exercised or considered.
- Print the difference – the Fed could retire outstanding bonds by printing dollars to purchase them and print the dollars needed to pay for unfunded liabilities.
Setting interest rates low at zero or negative may work as long as the market doesn’t demand higher rates in return for the risk of not being repaid in full or paid in “printed dollars”. The above courses of action could undercut confidence in the dollar and cause extreme price inflation.
U.S. Treasury options
- Extend the payment periods on U.S. Treasuries.
- Partially default on U.S. Treasuries – either on all Treasuries, Treasuries held by foreigners, and/or Treasuries held by the Federal Reserve.
- Fully default on U.S. Treasuries – either on all Treasuries, on Treasuries held by foreigners and/or Treasuries held by the Federal Reserve.
The U.S. Treasury options can be instituted by Presidential Executive Order as when Richard Nixon instructed the U.S. Treasury in 1971 to suspend gold payments to foreign banks in exchange for their dollars as was their right under the Bretton Woods Agreements of 1944. Any restructuring of the payment terms or default on U.S. Treasuries, however, would also cause a crisis of confidence in the dollar and result in extreme price inflation and higher interest rates that would have a deleterious impact on the U.S. economy.
Fiscal policy options
- Raise taxes – Raising taxes on ‘the 1%’ is often cheered on by populists and socialists as a solution to just about any of the nation’s woes, but taxing the 1% wouldn’t pay off the U.S. debt or cover its unfunded liabilities. In order to make a meaningful dent on the U.S. debt, taxes would have to be boosted to ridiculous levels (100%?) on all income earners and a host of new taxes instituted. Higher taxes on everyone would kill consumer spending (which is approximately 70% of U.S. GDP) and bring the economy to a standstill.
- Cut government spending – only complete elimination of government functions and agencies could possibly make a difference on the debt. Slashing the military budget in half and eliminating most or all federal agencies would certainly create a “untenable” situation that virtually no politician would ever advocate.
- Slash/eliminate entitlements – Since politicians get elected by promising voters stuff, virtually no politician will advocate cutting or eliminating welfare, food stamps, student loan guarantees, medicare, medicaid, veterans benefits or social security, to pay off the U.S. debt.
- Fiscal stimulus- increase government spending/subsidies in an effort to boost growth – Fiscal stimulus programs often fail (Solyndra) or do not return economic benefits greater than their cost and thus they might add to the deficit.
Wishful thinking options
- Grow the economy and tax revenues will help pay off the debt and fund unfunded liabilities.
- What debt problem? There is no debt problem – this view points to other countries that are more indebted as evidence that there is nothing to worry about. This view also holds that demand for U.S. Treasuries will continue to be robust such that bonds can be rolled over for an indefinite period of time.
Conclusion
Trump has a talent, for intentionally or inadvertently drawing attention to issues that get little or no attention and making them issues. Discussion of the U.S. debt situation is one with no easy solution and one not many politicians have been willing to address. It’s far easier for politicians to address issues where it’s easy to have an opinion and easy to make appeals to their constituents, like whether there should be transgender bathrooms. It is uncertain whether Donald Trump will continue make an issue of the national debt during the campaign. If he doesn’t, the issue won’t go away, it just won’t be solved.
This article by BGASC is not, and should not be regarded as, investment advice or as a recommendation regarding any particular course of action.