The U.S. national debt is in uncharted territory

January 7th, 2023

Thanks for joining us this Saturday morning. Today we’re talking about the national debt, which has ballooned to a proportion of GDP never before seen in American history.What are the risks? What happens if it keeps growing? Will we – or should we – ever pay it off?

The answers from economists and policy wonks run the gamut. There is no consensus – because nobody truly knows.

That should scare everybody.

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The U.S. national debt right now is $31.5 trillion, or 121% of GDP. Never in American history has the national debt been so high, either nominally or as a proportion of GDP.

The only comparable period is the immediate aftermath of World War Two, when debt reached 119% of GDP. Bill Clinton is the last president whose term saw the debt-to-GDP ratio decline from when he took office to when he left.

In 2000, the national debt stood at $5.7 trillion. And a decade ago, the debt was $16 trillion – just half what it is today.

A storm of complacency and short-term political calculations, abetted by historically low debt financing rates over the past 20 years, has left the national debt as an afterthought in policymaking.

Part of the problem is true debt and deficit reduction will require changes to popular entitlements. So-called “mandatory spending,” which includes Social Security, Medicare, Medicaid, and other safety net programs, consumed 73% of federal spending in 2021, and debt service accounted for another 4%.

There is simply not enough money to slash in the remaining 23% – which includes the defense budget – to meaningfully cut into the debt balance.

And the problem will only worsen in coming years. Interest rates are no longer at historic lows, so the cost of just financing the national debt will consume a much larger proportion of annual spending. The cost of paying interest on the national debt may even eclipse annual defense spending as early as 2029, according to the New York Times.

What’s more, as people live longer, the cost Social Security and Medicare, which consumed 40% of total spending in 2021, will increase.

Source: Congressional Budget Office

For these reasons, the nonpartisan Congressional Budget Office warned of potentially dire consequences if the current trajectory doesn’t change.

“The likelihood of a fiscal crisis in the Untied States would increase,” the CBO wrote last year. “Specifically, the risk would rise of investors’ losing confidence in the U.S. government’s ability to service and repay its debt, causing interest rates to increase abruptly and inflation to spiral upward.”

What the CBO describes is a sovereign debt crisis similar to what plagued southern European countries ten years ago and what occasionally causes economic collapse in South American and African countries.

That type of concern echoes what fiscal hawks have been warning about for years.

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But others paint a rosier picture.

Proponents of a radical new economics, called modern monetary theory (MMT), argue the government can simply print more money whenever it wishes – and should do so to pay off the debt and fund expansive social programs.

The only real constraint on the printing press should be inflation, according to MMT. And even then, the solution isn’t necessarily to stop printing – it’s to stymy inflation via fiscal policy (i.e., higher taxes).

In this way, MMT flips traditional conceptions of fiscal and monetary policy on their heads. The money supply should track what’s necessary to pay for goods and services, and fiscal policy – the tax rate – should respond to inflation, not revenue needs.

Not surprisingly, MMT has been roundly mocked by nearly every corner of mainstream economics. Former senior economic advisor to President Obama, Larry Summers, equated the theory to “fad diets [and] quack cancer cures.” Federal Reserve Chair Jerome Powell said the theory is “just wrong.” In a poll of economists conducted by the University of Chicago’s Initiative on Global Markets, 0% of respondents agreed with core tenets of MMT.

Even so, MMT has gained prominence among Democratic policymakers, though they’ve been more muted since inflation has raged over the past year.

Still others occupy something of a middle ground. Yes, policymakers should pay attention to debt and deficits, but they should not view the federal budget as similar to state or household budgets.

In a paper posted on the St. Louis Fed’s website, economist David Andolfatto writes, “To the extent that the national debt is held domestically, it constitutes domestic private sector wealth… it seems more accurate to view the national debt less as form of debt and more as a form of money in circulation.”

Andolfatto offers some fairly sophisticated economic theory to support his position, which is worth a read though we won’t repeat it here. But he concludes with this: “There is presumably a limit to how much the market is willing or able to absorb in the way of Treasury securities, for a given price level (or inflation rate) and a given structure of interest rates. However, no one really knows how high the debt-to-GDP ratio can get. We can only know once we get there.”

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The only consensus, then, is there is no consensus. This fact underscores two realities.

First, we’ve never been in this situation before, so nobody truly knows what might happen.

And second, we’re executing a real-time macroeconomic experiment, with a massive economic crisis well within the range of potential outcomes.

For much of the country’s history, the risks of the unknown helped reign in deficit spending. But over the past 20 years, that fear least among policymakers, seems to have dissipated.

That should scare everybody.