We have heard a lot about the debt and deficit spending. It’s long past time to take a look at this problem, because misinformation is rampant. You’re going to learn that having a national debt, even as large as America’s, is not in itself a problem. Let’s take a closer look at the comparisons between debt and GDP to get a better understanding.
U.S. Debt
Before we jump into comparisons and ratios, let’s quickly recap the deficit and debt. Remember the deficit refers to the amount of money the government has to borrow each year, while the debt is the cumulative total of everything borrowed so far. The total debt is $19.5 trillion. The expected total deficit for 2016 is $580 billion, which raises the debt by roughly 3 percent.
When you add interest rates, the debt is expected to rise to just under 8 percent over the next year. These numbers are a starting point, but it’s also important to understand how the debt is allocated.
Right at two-thirds of the debt is internal. It comes in the form of outstanding bonds held by U.S. citizens, banks, companies, government divisions and the Federal Reserve.
The other third of the debt is owned by foreign entities, with the biggest holders being the Chinese and Japanese national banks. For the sake of comparison, note that 95 percent of Japanese debt is held domestically, whereas Greek debt is 83 percent foreign. We’ll revisit these examples later.
GDP
The current state of the GDP is another key figure. It stands at $16.77 trillion per year, but 2016 is expected to finish with a total growth rate under 2 percent, which is the lowest since 2009.
Before we jump into the deeper points of ratio analysis, understand that for 2016, the debt is growing faster than the GDP, both as a percent and in real dollars, and by pretty much every economic measure that is not sustainable. So, the search for actionable resolution begins.
Comparing Ratios
Comparing GDP to debt is not a perfect measure, but it’s usually the easiest initial analysis. It’s important because GDP reflects tax revenue. Regardless of tax rate changes, if the GDP increases, so does revenue, and vice versa, and this is important for determining whether or not a country can sustain its borrowing.
Currently, the debt to GDP ratio for the U.S. is 105 percent, meaning the country owes 5 percent more in total debt than it makes in a year.
Let’s look at a few other countries to frame that number. Japan’s current ratio is 229 percent, and Greece is sitting at 175 percent. We can add perspective when we consider that Japan’s economy is considered one of the strongest in the world, and their borrowing rates are as low as possible. Greece, on the other hand, is defaulting on loans, and their loan to revenue ratio is considered unsustainable.
We can add to our framework by also comparing historical U.S. data. The highest ratio the U.S. has seen was in 1946, where the ratio was 121.7 percent. WWII spending caused massive debt spikes, but by 1974 the ratio was 31.7 percent. The most important point here is that the debt did not decrease during this time. The ratio changed strictly because of the GDP boom during that time.
Trump Policy
This brings us back to modern policy. There are a few troubling warning signs with the country’s current rate of debt, but most of the worry comes from declining GDP growth. There are two approaches to resolving the problem. We can raise taxes to reduce the deficit, or we can stimulate the economy to grow the GDP, and this was a major point of disagreement between the two parties this election season.
Trump’s plan is to jump start the GDP so it will outpace the rising debt, and world history suggests that this is the most sustainable plan. If the policies succeed, tax revenue will hit new highs within two years of policy changes, enabling the government to reduce the deficit while revenue continues to climb.
As nice as this plan sounds, it won’t be easy to achieve. The U.S. needs to return GDP growth to 5 percent or higher for a sustainable resolution. This will require large-scale reform over the next 16 months. If that can’t be achieved, the plan will have to change drastically.
Regards,
Ethan Warrick
Editor
Wealth Authority
