Sustainability

August 12, 2020 - Published by IAG Wealth Partners

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A very long time ago on December 31, 2019, the U.S. government’s total debt amounted to a mere $23,201,380,134,806.73.

Today that amount has grown to $26,498,433,296,171.26, an increase of $3.3 trillion or 14% in a matter of 7.5 months. Given the fiscal response necessary to keep our economy from complete collapse during a global pandemic, many would say this debt addition is well worth it.

Now Congress is negotiating another pandemic response bill that could add another $1 to $3.5 trillion to the debt. Having suspended our country’s debt limit until August 1, 2021, Congress has left itself plenty of flexibility for driving the debt higher.

But at what point does the national debt become unsustainable?

Thankfully, taxpayers do not need to pay interest on the entire debt. About $5.9 trillion of the debt is actually intra-governmental loans (mostly to the Social Security Trust Fund) where the interest is simply paid by adding to the debt balance.

That leaves about $20.6 trillion in debt that is owned by people, organizations, or countries that expect to be paid interest in cash on a regular basis and have their principal returned to them when their loan matures.

According to the Congressional Budget Office, we will be spending over $400 billion on interest to our debtholders this year in an extremely low interest rate environment. While not a small amount, $400 billion is likely sustainable given our potential economic output.

The challenge becomes when both the amount of debt and interest rates rise. Congress can theoretically control the former, but the latter is unpredictable. The most likely sources of interest rate increases are creditworthiness and inflation.

If bond investors start to believe that the U.S. has taken on too much debt and that there is a higher risk that future interest or principal payments may be at risk, they will start to require a higher interest rate on that debt until their fears are quelled. This can become a self-fulfilling fear as higher interest costs will make our country’s annual budget problems significantly worse.

If bond investors start to believe that higher inflation is coming before their bonds mature, they will start to require a higher interest rate on that debt until their fears are quelled. The Federal Reserve is tasked with managing price stability, and they could exert their influence to keep interest rates lower by buying U.S. debt (as they are doing right now). Historically printing currency to buy national debt over long periods of time results in a weaker currency, higher future inflation, and poor economic performance.

Right now central banks for every major global currency are all printing money and buying debt, so on a relative basis the United States looks to be in good shape.

Sustainability begins to shift to unsustainable when bond traders begin to think a different country or currency may hold its value better or provide less risk to principal. We are blessed that such an option does not exist today which makes our rising debt affordable for the time being.

However, in the distant future it is entirely feasible that another country or currency will develop with credibility that exceeds the United States. If that occurs we will realize that less debt is more sustainable and today’s short-sighted decisions created tomorrow’s long-term challenges.

 

 

Quote of the week: Thomas Jefferson: “To preserve our independence, we must not let our rulers load us with perpetual debt. We must make our election between economy and liberty, or profusion and servitude.”


Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through IAG Wealth Partners, LLC, (IAG) a registered investment advisor and separate entity from LPL Financial.

Past performance is no guarantee of future performance. In fact, the opposite can be true. The information contained in this report does not purport to be a complete description of the securities, markets, or development referred to in this material. Investing involves risk including loss of principal.

Any opinions are those of IAG and not necessarily those of LPL Financial. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. No strategy assures success or protects against loss. Investing involves risk including loss of principal.

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