We frequently receive questions from clients regarding the sustainability of U.S. government debt. According to the U.S. Treasury, the American government has run a budget surplus only four times in the last 50 years, with the most recent being in 2001. The strong economic growth through the late 90s technology boom was the primary reason for the surplus. Fiscal spending in response to COVID caused the cumulative national debt to balloon to $34 trillion, not including unfunded liabilities for Social Security and Medicare.
What allows the U.S. government to spend this way is the fact that the dollar is the reserve currency of the world, and the U.S. Treasury market is the deepest and most liquid securities market in the world. Treasury assets are often a haven for domestic and international investors. This reserve currency privilege has allowed elected officials to spend well beyond the tax revenues that are received each year, effectively giving lawmakers a blank check for spending. As dire as this all sounds, this does not foreshadow a coming debt crisis in this country in the medium or even long term.
The ratio of debt-to-GDP in the U.S. is currently at 125%. Prior to COVID, the debt-to-GDP was closer to 100%. While this debt-to-income ratio seems high, it has plenty of headroom to continue to grow. In Japan, the debt-to-GDP is 267%; this is an extreme example that is helped by low interest rates and the fact almost all Japanese government debt is owned by its citizens. Ultimately, the debt-to-GDP ratio can continue to grow for a long time with no real consequences. Additionally, as long as the dollar remains the reserve currency of the world, the U.S. will be able to continue its spending patterns. We believe there is no other currency or basket of currencies that can replace the U.S. dollar, further adding to the longevity of the current fiscal situation.
How the U.S. will dig itself out of this circumstance is unclear. A country can inflate its way out of debt, grow its way out or default on the debt. Default of U.S. debt is not an option, as this event would put the global economy back to the stone age. Inflating our way out is also not an alternative, as inflation is a highly regressive tax on citizens and often causes political turmoil. This leaves the option to grow out of the debt, which is a difficult proposition, however there is some good news on this front. Productivity gains, or greater output per unit of input, is the holy grail of economics. We are just starting to see the impact of artificial intelligence on productivity, and it should be meaningful. The last budget surpluses in the economy in the late 90s was in part due to the productivity gains from the internet. While the productivity gains from artificial intelligence (AI) and resultant higher growth in the economy will not be enough to wipe out the national debt, it could slow the growth of debt and further extend the fiscal sustainability of the country.
This week, June’s consumer price index report was released and demonstrated that inflation continues to cool. The Federal Reserve continues to monitor the data of cooling in the labor market and inflation to determine when to begin to lower interest rates.
Takeaways for the Week
We do not see a coming U.S. debt crisis, there is a lot of headroom for the current indebtedness to continue
Growth in productivity from artificial intelligence should further allow the U.S. fiscal situation to be sustainable