Who's Going To Pay the US National Debt?

As I write, the public debt (sometimes called the national debt) of the US stands at $6.3 trillion, roughly 40% of GDP. (You’ve heard many people say that the debt is actually about $10.6 trillion, but that’s fictional, as I explain below.)

As we know, the question of who will pay off the debt is an interesting and urgent one. Especially now that, through a combination of fiscal stimulus, existing entitlements, declining tax revenues, and new programs like universal healthcare and a “green” economy, the public debt is going to skyrocket in each year of the coming administration.

It seems more likely than not that we’ll be adding between one and two trillion dollars in new debt to the outstanding total in each of the next four years. It took President Bush eight years to add $3 trillion to the public debt. Obama will probably add twice as much debt, in only half as much time.

And as I’ll explain, it’s good and likely that we’ll be adding large amounts of new debt in the years after the next four, as well.

First let me explain the difference between “gross debt” and public debt. The gross debt of the United States government includes the Social Security trust fund. Social Security is usually described as a “pay-as-you-go” program. In fact, however, it collects more money through the payroll tax than it pays out in benefits. The remainder is spent by Congress on other stuff, in effect understating the federal budget deficit by the amount that Social Security is overfunded in each year.

The difference is also accounted for with special debt securities that the Treasury writes to itself. This is the “trust fund.” These debt securities don’t actually represent an enforceable claim on public assets (other than in the public imagination, which believes that real money is being stored somewhere, in order to pay Social Security benefits in the future). That’s why it doesn’t mean much to include the trust fund in our analysis of the public debt.

Subtracting the trust fund from the $10.6 trillion “gross” national debt leaves a public debt of $6.3 trillion. This is the amount of debt that the United States owes (and must someday pay) to actual people and institutions like investment funds and foreign central banks.

Now take a look at why we have to deficit-spend in the first place. If you add up the amount that Americans consume and invest, and subtract the amount that we save, you get a number that is correlated with GDP. And it also correlates with the material well-being that Americans experience. The amount by which the desired actual amount of consumption and investment exceeds the productivity of the economy is a structural deficit, which can only be filled by importing capital and/or goods from surplus countries. In times of recession, when the economy is producing goods and services below its capacity, the actual gap is even higher.

The government adds its own demand to the mix, in the form of stimulus, and spending for entitlements, earmarks, and war. That increases the amount of deficit we have to make up every year. And this adds ever more to the public debt, because we have to borrow it from somewhere.

Until 2008, government indebtedness would grow more or less every year, but private indebtedness was also growing at a very fast rate. This was possible because the private sector could (anomalously) borrow lots of money at relatively low interest rates. That borrowing ended abruptly with the appearance of the credit crunch.

Government, which (perhaps also anomalously) can still borrow at exceptionally low rates of interest, naturally has been forced to pick up the slack. The only alternative to this would have been a sharp and very noticeable falloff in personal consumption, considerably exceeding the recession that actually materialized. Hence, the explosive rise in the public debt.

Obama is taking this burning fire and pouring gasoline on it by proposing to deficit-spend literally trillions of dollars, in the hope of masking the reduction in consumption that has manifested as a recession. Let’s say he gets away with deficit-spending about three trillion extra dollars over the next two years, and that the economy then recovers. (It won’t, but forget about that.)

From that stimulus alone, we’ll have increased our public debt from about 40% of GDP to about 60%. (That measure is relevant for the same reason that your bank asks you how much you make, when deciding how big a mortgage payment you can afford.)

But that’s not the end of the deficit spending in the out years! The structural deficit, which we would be responsible for even with an economy running at full strength, includes the commitments we’ve already made to fund retirement and medical benefits for the baby boomers, and whatever else Obama can ram through Congress. (Notably, universal healthcare and subsidies for the wind and solar-powered automobiles that he promised today in his inaugural address.)

We can’t raise taxes to make up the deficit shortfall. Even if it were politically palatable, it wouldn’t be economically possible. You simply can’t displace that much consumption from consumers to the government’s priorities without causing an unacceptable decline in living standards.

We could make up some of the gap by radically increasing the productivity of the US economy. This could be done quite effectively by cutting marginal tax rates on capital, business income and exports. Which will never happen as long as Democrats hold power in Washington.

And we can’t cut government spending. As long as Democrats hold power in Washington, entitlements and discretionary spending will rise rapidly, rather than fall.

That means we’re going to be borrowing trillions of dollars, possibly every year, for a very long time to come. Where’s that going to come from?

It’s going to come from the surplus countries, those that produce more goods, services, and/or commodities than they need to meet domestic demand. (The key surplus countries today include China, Japan, Germany, Norway, Switzerland, and the oil-exporting countries in the Middle East. South Korea recently slipped into deficit. Russia’s status is unclear, given the decline in the oil price.)

The standard argument is that, as the dimensions of the federal deficit become clear, global investors will push up long-term interest rates, collapse the value of the dollar, and stop buying our debt.

Forget about the fact that this argument has been made for 25 years and has never been correct. Going forward, there are important reasons why foreign investors will continue to buy our long-term debt, support the value of the dollar, and fund our deficits.

And that’s simply because the surplus countries to date have shown little inclination or ability to increase demand in their own economies. There’s little reason to think that will change. They face a continuing need to import our demand. Over time, there is an opportunity for one or more of those countries to make structural changes and take over economic global leadership, but again, there’s no evidence that any of them are so inclined.

We’re going to need to engineer a grand symbiosis in the global economy, requiring careful (and probably secret) diplomacy, to keep the existing pattern of international capital flows going. Even though that pattern represents a large, growing, and ultimately unsustainable imbalance.

Much as the US needed to incur a public debt level approaching 100% of GDP in order to fund World War II, we will now need to do the same thing to fund the retirement of the baby-boom generation. Extending the debt to well beyond 100% of GDP is unprecedented and hard to speculate about. (Japan is running a public debt of 300% of GDP, but as a surplus country, relatively little of this debt is owed to non-Japanese investors.)

It took about 15 years (during a time of extraordinary economic growth) to get the debt from World War II down to a manageable level. It took the British Empire much of the nineteenth century to work down the debt from the Napoleonic Wars.

This is a plausible strategy. It sounds weird, and it will require an extraordinary amount of international cooperation, but it can be done.

I know that integrated global governance is one of the grand dreams of the American Left, which Obama now leads. But you probably didn’t realize that it can be accomplished without a public debate.