In following the fiscal cliff debate, it is good to know some detail on U.S. government debt. How big is it? To whom is it owed? Will it be a burden on our children?
U.S. government debt, how big?
As of December 21, 2012 total U.S. federal government debt was $16.3 trillion. To put this in perspective, it is about the same amount as total income that the U.S. economy currently produces (our GDP) annually.
About $4.8 trillion of the federal debt is “interagency debt” or debt that one part of the government owes to another part. This is not really debt in the traditional sense. It’s as if you were to take your monthly income and put part of it in your right pocket and the other part in your left. As you spend over the course of the month, the money in the left pocket begins be drawn down, so the right pocket makes a loan to the left. This may make you feel more balanced, but it is not an increase in debt.
Subtracting interagency debt leaves total federal government debt to the private sector at $11.5 trillion. About $5.5 trillion of this is held by foreigners, leaving $6 trillion owned to U.S. citizens, businesses and financial institutions. Of the amount owed to foreigners, $1.2 trillion is owed to China.
Is the debt a burden being left to our children ?
It is often said that the debt is a burden that we are leaving to our children. Some commentators even contend that this is immoral. But that is not accurate, since some of our children will be owed the debt, the ones who bought or who inherited government bonds, we could just as easily describe the U.S. government debt as assets that we are leaving to our children.
Is the debt, including that owed to foreigners a problem?
The $5.5 trillion of U.S. government debt held by foreigners could be considered a problem since it represents foreigner claims on U.S. goods and services. On the other hand it also represents some degree of confidence that foreigners have in the U.S. economy, otherwise why would they invest in U.S. bonds?
Foreigners who hold U.S. government bonds can sell them for dollars and use those dollars to buy U.S. produced goods, services and real assets in the United States. But it is unlikely that such a move would take place suddenly by all foreign holders of all their U.S. bonds, since it would send the prices of those U.S. bonds sharply downward and cause a loss of value for the holders. And it would raises interest rates on those bonds, making it more lucrative to buy U.S.bonds rather than sell them.
But here is where there is a grain of truth to the notion that the U.S. government debt is a burden we are leaving our children. In the future, as foreign holders of U.S. bonds gradually redeem the bonds for dollars or are paid interest in dollars on the bonds, they can use the dollars to buy U.S. goods and services. As they do this, it leaves a smaller share of those goods and services for our children to enjoy.
What we do with the borrowing is crucial
Like all borrowings, what is critical is what we do with the loan. In the current struggle to get the U.S. economy back to full employment, if the U.S. government debt, including the portion held by foreigners, were to allow us to stimulate demand for goods and services, leading businesses to hire more workers to increase production, we could forestall a deterioration in worker skills that results from long term unemployment. It could speed up the accumulation of experience that comes from working on the job that so many of our youngsters entering the labor force with degrees from college are forced to forego in this less than full employment economy. It could help other youngsters gain experience and skills in manufacturing or as helpers with plumbers, carpenters, electricians and so many of the other needed trades, if only they could get the jobs.
And If we use the funds to help strengthen our infrastructure – our roads, bridges, mass transit, improve our airports, electricity grid, schools and educational system, clean our water and water ways, improve our safety and health and military, then we will have used the loans from foreigners to good effect and the things we will have accomplished with it will have represented a gift to our children that could more than compensate for the debt owed to foreigners.
This would be a gift to our children well worth the legacy of some federal government debt.
Paying off the debt
The reality is that the federal government debt never needs to be paid off, only the interest on it needs to be paid. A fiscally strong nation can always “refinance its debt.” by issuing new bonds to pay off old bonds. This does little harm to a nation whose output capacity (GDP) is growing faster than its debt, in which case debt as a percentage of its income (GDP) shrinks.
A government debt that is under control in the sense that it is not growing at a rate faster than is its GDP is a benefit to a capitalist economy. Can you imagine an economy without government bonds? It is certainly possible. In such a world high grade corporate bonds would probably take the place of government bonds as a safe haven asset. But corporate bonds would be a poor substitute for bonds backed by the full faith and credit of the U.S. government in a vibrant growing U.S. economy. By being a true safe haven asset, government bonds act as a lubricant that helps the economy function smoothly.
As long as the U.S. economy remains strong, the U.S. government debt can be continuously “refinanced.” The key is that we want our GDP to be rising at rate at least equal to and probably a bit faster rate than is the debt.
What we should wish for in a grand bargain to avoid the fiscal cliff is a deal that would set the long term trajectory of U.S .government debt to one below the trajectory of the growth in U.S. gross domestic product.
If we can manage that, we and our children will be in good shape.
See a proposed compromise solution to solve the fiscal cliff problem.