Will The US National Debt Cause Problems Soon? (EP.158)

0:28We all need to make smart decisions with our money. and misunderstood topic, the U.S. national debt. With the current debt sitting at about$34.6 trillion as of this recording, many may wonder if this signals an impending crisis. Let's break down what this figure means and explore the broader implications. And as always, you can find detailed show notes and resources related to this episode at thelongterminvestor.com. Now I'm going to start with some definitions, because I often hear people getting the national debt confused with deficits and the debt ceiling. Simply speaking, a deficit is the amount in which a government spends more than the revenue it brings in for a given fiscal year.

1:13When people say we need to reduce the deficit, what they're suggesting is that we either need to spend less, whether that's on roads or defense or social programs, or they're suggesting that we need to generate more revenue, most likely in the form of higher taxes. To pay for a deficit and cover the revenue shortfall, the government borrows money issuing treasuries. The national debt, that is the accumulations of past deficits and surpluses, as well as any of the associated interest owed to treasury bondholders. In other words, the national debt is the amount of money the federal government has borrowed to cover the outstanding balance of expenses incurred over time.

1:57You could think of the national debt being similar to a person using a credit card for purchases and not paying off the balance each month. The cost of purchases exceeding the amount paid off represents a deficit, while the accumulated deficits over time represent a person's overall debt. But the parallels between government finances and household finances end there. In fact, understanding the flawed nature of comparing the U.S. government's finances to household finances is one of the most important takeaways for this episode. But I think we need to cover a few more basics to understand why. We know what the national debt is, we know what the deficit is, and we know how they're different.

2:41And while our country's total outstanding debt makes for really eye-catching headlines, the dollar amount of debt is generally viewed as less important than its proportion to the country's gross domestic product, or GDP, which is the economic term for economic growth. And so people are going to look at the debt-to-GDP ratio because a country's tax base grows alongside its economy, meaning that it increases revenue that the government could raise to service its debt. Now, as of the close of the fourth quarter of 2023, the U.S. national debt-to-GDP ratio was 121.63%. And Investopedia has a really nice chart showing the history of this ratio, which I've shared in the show notes at thelongterminvestor.com.

3:29And this is a high ratio, and many expect it to increase. As the baby boomers, they're going to continue to retire and begin collecting Social Security and Medicare. Some people will exclude the debt held by those trusts that fund Social Security and Medicare when evaluating this debt-to-GDP ratio because the interest our government owes on those Treasury securities is to itself. Next week, I'm going to be covering the state of Social Security's finances and how it impacts financial planning for people at different life stages, so I'll explore that a little bit further when discussing that topic.

4:05But for now, let's recap what we've learned. we have defined deficits in the national debt, how they're related, how they're different. We've introduced the ratio of debt to GDP, which most people place greater weight in than the total amount of total outstanding national debt. One final thing before moving on to what I think is the really good stuff, and that is the debt ceiling. The debt ceiling is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations. Those obligations include paying interest on the national debt, Social Security and Medicare benefits, military salaries, tax refunds, and other payments from the continuation of public goods and services.

4:48The debt ceiling is different than the budget, which Congress passes every year, and the budget includes spending on these items I've just mentioned as well as many others. The debt ceiling doesn't really have anything to do with authorizing new spending commitments, that's the budget. The debt limit simply allows the government to finance legal obligations that Congresses and presidents of both parties have made in the past. Again, the debt ceiling is a self-imposed restriction on borrowing. So as we get into some of the nuances of what our debt actually means, you have to remember that those debt ceiling debates are purely our own restrictions.

5:28And in many ways, the debt ceiling is somewhat antiquated. It's a topic I've talked about in past episodes. I'll be sure to link to those in the show notes at thelongterminvestor.com. But now that we have some good definitions in place, let's focus on how to think about the ever-growing U.S. national debt. And I have a surprise for you, but you need to keep an open mind. I'm serious. Are you ready? Really? I'm serious here. Take a moment and tell yourself that this is an opportunity to learn something new. Long-time listeners have heard me and guests on the show talk about how our brains naturally reject new information that doesn't align with our existing worldview.

6:10Maybe I'm building this up too much, so I'm just going to say it. Deficits and the national debt don't really matter. We are not going to run out of money. When people hear me say that, they're always a bit skeptical, but the more you understand about modern monetary theory, the more it begins to make sense, particularly in the context of the actual evidence available. The orthodox economics that was taught to you when you were in school not only conflicts with the actual evidence, but hasn't been relevant since the United States ended the gold standard in 1971, severing the link between the US dollar and the value of gold.

6:52I might dedicate an entire episode to modern monetary theory, but here's a quick explanation of it. Modern monetary theory is a framework, a branch of macroeconomics, and I feel like the word theory does it a disservice because it really isn't as much of a theory as it is a description or this coherent macroeconomic framework that resembles the actual monetary system we have today, as opposed to the one that we had pre-1971 when the US dollar was still tethered to the price of gold. We now have fiat currency, which means that it has a floating exchange rate instead of a fixed exchange rate, and that opens up policy space, both in terms of monetary policy and fiscal policy.

7:36The implications of having a fiat currency are very different for what the government can afford to do. The old way of understanding the government and the economy is thinking about it like household finances, where your spending is restrained by your income. And we've all been indoctrinated to some extent by the constant refrain that the, quote, government should get its fiscal house in order. And when you hear language like that from politicians, they are implicitly telling us to think about the national debt as we think about our household finances. And they're telling us how reckless and irresponsible it must be for the government to continually spend more than it takes in, and to borrow and to take on debt.

8:19They just want us to think like a household. But federal deficits are actually good for the economy. To understand why, you have to think in aggregate terms. So let's start at the simplest level. Imagine the entire economic and financial system divided into two buckets. One bucket has the words government finances on it. And the other says non-government finances. We know that when a government runs a deficit, that means it's spending more dollars than it's bringing in. So in the two-bucket system where the government is running a deficit, that means it has less money in its bucket than it started with.

9:02And there's really only one other bucket that that money could have gone to. And yes, you got it. You are a quick learner. That's the non-government bucket. When the federal government runs a deficit, that means the non-government has a surplus. Or said another way, a deficit is good for someone other than the government. Like I said earlier, this isn't theory. This is math. This is an accounting identity that I've just described. It's an irrefutable statement and something you can actually see coming out of the national income and product accounts and can be seen in the flows data. I mean, think about it.

9:40How else could it work? If the government spends$100 and only collects$90 in taxes from the non-government sector, somebody in the non-government sector gets$10. And again, you can see this in the real data. It's a one-to-one relationship. The flip side of it is that if the government is running a surplus, the non-government sector is running a deficit. Are you still with me? Because I have never wanted more on this podcast to have a piece of paper to draw this on for you. So go ahead and click the rewind button a few times to listen to that again so that you can visualize it. Because a fiscal deficit, a government deficit, works like a leaf blower.

10:20It's blowing dollars out of it and onto someone else's balance sheet. And when the government's budget is in surplus, it's the opposite. It's more like a vacuum, siphoning dollars off our balance sheets. It's important to internalize this, to be convinced that deficits are actually good for anyone that isn't the government. But you may still ask, how are we going to pay back all that money? How is it that the national debt, the accumulation of all of our past deficits and surpluses, how is it that it isn't something to worry about? After all, I did initially compare the national debt to having a credit card where you don't pay the balance each month.

11:03The shortest version of this is simply that the federal government doesn't have to budget like the rest of us because it can print its own currency. This was a big discussion point in the last episode where we were discussing the US dollar status as the world's dominant reserve of currency. I've linked to that in the show notes. You can also just click back one in your podcast player. But this is the essential fact underpending the ideas I've laid out thus far. The U.S. federal government is the sole manufacturer of dollars. Being the monopoly issuer of the U.S. dollar gives our government some very unique abilities as long as they promise to never convert the currency into something they could run out of, like gold or another currency.

11:47and they also have to promise not to take on debt denominated in a currency other than their own. This is actually what happened when Greece was running into some issues following the great financial crisis. It's all really because they stopped issuing the drachma in order to use the euro. They gave up their monetary sovereignty and they couldn't simply print money to repay their debts. Instead, they were forced into the very situation people mistakenly use to scare us in the U.S. about our debt. Because the United States, on the other hand, can always pay its bills because they can simply create money out of thin air.

12:25In fact, I have a quote that I remember jotting down from Fed Chairman Ben Bernanke, who was once pushing back on the idea that taxpayer dollars were what bailed out Wall Street during the financial crisis. And he explained, quote, the banks have accounts with the Fed. We just use the computer to mark up the size of the accounts. All it took was a few strokes of the keyboard. Similarly, America isn't dependent on foreign countries for financing, which is a pretty common thing I hear from people. All the time I'm hearing, we're dependent on China to finance our elaborate national spending. But that just isn't so.

13:05China runs giant surpluses. And so let's go back to the two-bucket system. But this time, one bucket is China's government. And the second bucket is literally everybody else in the world. When China runs surpluses, that means they're selling goods and services to other countries, acting more like a vacuum than a leaf blower and sucking in money that's denominated in currencies of those running deficits. And when China has U.S. dollars, they have a choice. They can hold those dollars, they can sell those dollars, or they can trade them in for interest-bearing versions of the U.S. dollar that we have all now come to known as treasuries.

13:43Yes, those treasuries pay interest, but again, the U.S. can print money to cover that interest cost. Now, I'm really teetering on the edge of a deep dive on modern monetary theory, so I'm going to stop there and really just say, in short, the U.S. cannot run out of money because it can print as much money as it needs. And as a result, deficits and the national debt don't really matter. The risk of default is effectively zero. But here's the thing, as you economic wonks know, there is consequence to printing too much money, and that's inflation. Once you recognize that the federal government faces no purely financial constraint, then people usually start to think about the government's spending to infinity.

14:33But there is this inflation constraint. The limit is basically our economy's ability to safely absorb whatever new spending Congress authorizes. For the past few decades, the U.S. economy has absorbed trillions of dollars of deficit spending, but the fiscal response to the pandemic provides a very useful example of how aggressive spending can create inflation problems. So looking at deficit spending, in fiscal years 2020 and 2021, the US federal government ran an accumulated deficit of nearly$6 trillion, more than the cumulative deficit from the previous eight years combined, data that I have up on the long-terminvestor.com, and all that spending surely helped the U.S.

15:20economy avoid a potential depression rather than the quick recession it experienced. But we quickly saw inflation ignite for the first time in several decades because businesses couldn't keep up with the demand as they faced capacity constraints. To borrow from a more orthodox economic phrase, too many dollars chasing too few goods. And simply speaking, as we think about understanding the national debt, it isn't that deficits are evidence of overspending. It is inflation that is evidence of overspending. To summarize, understanding U.S. government debt requires moving beyond simplistic analogies to household finances.

16:02By considering the aggregate nature of economic sectors and the unique ability of the government to issue currency, we can better understand the implications of government debt. The real concern lies in managing inflation rather than fearing default. And hopefully this broader perspective helps demystify the often daunting figures associated with government debt. As always, thanks for listening. And until next time, to long-term investing. Thanks for listening to the Long-Term Investor Podcast. To access free financial resources and submit questions to be answered on the show, visit thelongterminvestor.com.

16:43Peter Lazaroff is an employee of PlanCorp and BrightPlan. All opinions expressed by Peter and any podcast guests are solely their own opinions and do not reflect the opinions of PlanCorp or BrightPlan. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of PlanCorp and BrightPlan may maintain positions in the securities discussed in this podcast.