Fisher Investments Editorial Staff
Media Hype/Myths

A Welcome, Yet Flawed Addition

By, 03/07/2011

Story Highlights:

  • Recent studies of US federal debt are a welcome addition to the conversation, but have flaws.
  • Very long-term projections, including non-debt items as debt, and other factors lead to conclusions data doesn’t support.
  • Currently, our interest payments on federal debt aren’t at all problematic.

We’ve long held that, if viewed correctly, one might come to reasoned conclusions about government debt if our national finances were viewed similar to corporate balance sheets. It’s not a perfect analogy and doesn’t always apply, but in our view, it’s pretty close and valid.  And recently, there have been a few attempts. But while recent publications on the topic have merits we won’t discount, it’s important to note the primary, serious flaws.

The studies’ long-term nature (most run through 2030 and use suspect Congressional Budget Office forecasts) makes for shaky conclusions. For one, very long-term projections about nearly anything are mostly assumptions based on more assumptions. And more assumptions mean more opportunity for error. For example, to facilitate the long-term analysis, most analysts are lumping in things that aren’t debt (like projections of Social Security’s and Medicare’s future liabilities) and calling them debt. Now maybe some folks think these should be included, but including them in a debt calculation misses a factual point: Social Security and Medicare’s costs aren’t debt, they’re entitlements.

Debt is a very specific thing: A contractual obligation between two parties, where a borrower and lender agree to a set of obligations (like an interest rate, schedule of payments, and maturity for instance). Maybe the borrower has some other provisions, like early repayment or restructuring, but that’s all contractual. Compare that to the entitlement programs in question: The government didn’t hash out the payment details with each citizen individually. Instead, and using Social Security as an example, Congress legislatively (and unilaterally) decided to take money from your paychecks, and in return, you may (or may not) get something back later. There’s no contract per se, and since there’s no contract, Congress can change the rules on you at any darn time and without your input. That’d be defaulting if Social Security were debt, but since it’s not, we call that “the way it goes.” And Congress has changed the rules—just a few years back they changed the eligibility ages for full benefits. Cookies crumbled!

Moreover, some also use gross debt, not debt held by the public. A further flaw! The biggest owner of America’s national debt is the government itself. Folks, that’s effectively an accounting entry—and since it’s on both sides of the balance sheet, it cancels.

And speaking of balance sheets, they should balance. Therefore, debt (held by the public) should be compared to our country’s assets—like real estate, timber, roads, bridges, minerals, etc., etc., and so forth. The US has massive, massive assets—something many analyses don’t attempt to include (nor is there an “asset clock” in Times Square).

Also, many folks seemingly gloss over the fact our national debt, as a percent of GDP, was higher in the WWII era than today. Since debt didn’t prevent large-scale future economic growth or drive default then, we’re not convinced today’s elevated relative debt level means assured doom. Perhaps that’s a morality question—some folks are fine with high debt if it’s funding war against Nazis (unquestionably a noble cause). But the bonds issued don’t care one iota for what cause they’re being floated. They care about the ability to meet debt obligations.

And the heart of a debt problem is the ability (or inability) to make required payments. So why is there so little discussion of how low of our nation’s current interest costs are as a percentage of tax revenue? Interest rates are and have been historically cheap, so our debt is cheap—whether compared to tax receipts or GDP.

US Federal Debt Net Interest Costs as a Percent of Tax Revenue

 

Source: Congressional Budget Office; as of 8/31/10. Data not yet available for 2010.  Tax Revenue includes Customs Duties & Miscellaneous Receipts

And before speculating where interest rates will go, recall that the 1970s and early 1980s stratospheric rates seem to be historically the exception—not the rule. Interest rates may certainly rise from current, very low levels. But even when our interest payments were a greater share of taxes received through the entirety of the 1980s and 1990s, problems didn’t ensue. In fact, that period was economically vibrant and featured two mega bull markets.

Ultimately, we welcome the contribution to our national debt discourse provided by recent analyses. And we have no quibble with government spending cuts (government spending can crowd out private sector investment and financing). We also agree we probably shouldn’t just grow our debt faster than our economy grows forever—but we doubt that happens. First, economic growth helps offset debt increases. Second, the political pendulum seems to be swinging towards at least more relative frugality (again making it easier for growth to offset debt).

Exercise skepticism about claims of looming American insolvency—with our debt so cheap that’s just not happening. Debt-doomers need to get comfortable with a couple facts: Our national debt is unlikely to be eliminated any time soon, and it’s equally unlikely to create a dire, nightmarish economic scenario.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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