As the election approaches, the subject of government debt will probably come up a lot, and many investors will therefore see it as a big problem…but is it? Should they be worried?
Unfortunately, like everything these days, debt will be discussed from a sharply divided partisan perspective. Republicans will hold it up as a terrible thing and will maintain that all of the problems can be blamed on the current president. Meanwhile, Democrats will pretend that there isn’t really a problem, and that running the federal government at a big loss during a time of full employment is a perfectly normal thing to do.
So, which is right? The answer is neither. Both positions, as is often the case when politicians disagree, are at best misleading and a lot of what they say is just outright wrong.
Debt isn’t always bad. Some level of US government debt is normal and healthy in a functioning free market global economy. The dollar is the world’s reserve currency and Treasury obligations are the safe instrument that forms the benchmark for measuring the return on any other investment, so some government paper must be out there for the global financial system to operate.
Nor is it a bad thing for America, or any other solvent country, to have some debt. It is an investment in the future. Just like how many of us have a mortgage that we use to buy shelter, a basic human need that is only affordable when the cost is spread over decades, so the government issues debt to pay for things that they deem necessary, but for which the immediate cost exceeds tax income. As long as that borrowing fuels growth, it is not an immediate problem.
That is why both political parties have a history of increasing the debt, with the difference coming only in terms of what that debt finances. The stereotype is that Republicans give tax cuts to corporations and billionaires and spend massive amounts on defense, while Democrats spend on welfare and projects to put money in the hands of the less well off.
There is some truth to those characterizations, but whatever the money is used for, the end result is the same: more government debt, which is why the 30-year chart for total debt looks like this:
The need, the desirability even, of some debt explains why the chart slopes inexorably upwards. The problem, though, is that the rate of increase is increasing. That is a trend that started in earnest back in the 1980s. If you look at the top 20 increases in federal debt by president over the years on a percentage basis, the two leaders by far are FDR and Woodrow Wilson.
They each dealt with a world war, while FDR also had to pull America out of the Great Depression, so they have pretty good excuses. It will, however, surprise many to see that the next name on the list is Ronald Reagan and that Joe Biden, who will come in for a lot of criticism over the debt, is at number 15, well behind Donald Trump, who will be doing the criticizing, who sits at the number 8 spot himself:
I am not saying that Biden has been a model of restraint. These numbers reflect only three years of his presidency as opposed to, say Reagan’s eight, but the point is that whatever you hear from politicians will inevitably be cherry-picked from the data, if data is even used at all. No party is better than the other at controlling debt. The last US President to see the federal debt fall under his presidency was Calvin Coolidge in 1923-1929.
It is also clear from this table that there isn’t one consistent cause of deficits and debt. Tax cuts (Reagan), unfunded wars (George W. Bush), and social welfare spending (Obama) can all increase the debt. In recent years, though, the biggest influence on debt has been monetary policy.
Interest rates fell pretty consistently from the 1980s until a few years ago, making borrowing cheap. If the government can borrow money for ten years at around 0.5%, as it could in 2020, not borrowing would be almost irresponsible. If that money is invested in the economy, even if badly, it should return more than that in terms of growth, and therefore tax revenues.
But the problem is not the government borrowing when it is needed or makes economic sense; it is the borrowing that follows those brief periods in time. Before Reagan, the government borrowed but there was a consensus view that that debt should be reduced when the economy was booming.
Reagan changed that.
The big tax cuts passed under his administration were stimulative to the economy, but they hurt revenue massively, and a failure to reduce spending or put taxes back up during the ensuing boom left a big hole in the accounts, a hole that was filled by borrowing. There was no incentive to reduce that debt when rates were falling, as refinancing it made it cheaper.
That became the playbook for subsequent administrations, and as long as interest rates were low and still falling, that wasn’t too much of a problem. As we all know, though, the last few years have been a rising rate environment.
To return to the original question of whether investors should be worried by debt, the answer is yes, because inevitably, that trend towards ever lower interest rates was reversed after they hit zero. The cost of debt servicing is now increasing, and over a third of the money spent on it will exit the American economy to pay overseas holders of Treasuries.
It is not, however, a worry that looks likely to be assuaged any time soon. In this election cycle, as always, the challenger will bring up debt as a way to attack the incumbent, but whoever wins, history suggests they will continue to borrow until either the market or some external crisis forces them not to. They have been doing it for 100 years. The $34 trillion US government debt is a ticking time bomb, but it may have to explode before anyone makes a serious attempt at solving the problem.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
