US Debt Perspectives

It's an election year. Which means, you can expect heated rhetoric on most any topic. But a near-constant go-to topic in any election year is debt. Politicians want you to believe they have the solutions to America's "debt problem," and the other side will only exacerbate it.

But here's a question almost no one asks: Does America truly have a debt problem? And what exactly is that problem?

Often, debt discussions only cover part of the picture. For example, there's a clock in Times Square counting up the size of US federal debt, but there's no clock counting up GDP or assets. In accounting, there's a dual ledger. But in punditry, not so much.

So let's cover a few key questions about America's debt and debt service to get a clearer picture.

What is the true size of the US's debt? And who actually owns most of it?

The government reports total outstanding debt daily-to the penny. The current total is $15.3 trillion. Of that, "intragovermental holdings" total $4.7 trillion, or 30.7%-most held by various government trust funds, revolving funds and special funds, the largest being the Federal Old-Age and Survivors Insurance Trust Fund, better known as Social Security. Yes-the US government owns roughly a third of its own debt. And that 30.7% is huge compared to approximately 7.4% owned by China or 6.8% owned by Japan (all figures as of 12/31/2011).

Government-owned debt effectively balances-what's a liability to one group is an asset for another. Thus, a better measure of US debt would net out the government's stake-net public debt. That figure is today about $10.7 trillion.

Now, some argue that ignores entitlement payments the government is slated to make in future years. But those payments aren't actually debt. They're entitlements which can (and historically have) changed. Debt is a very specific thing: It's a contract between a borrower and a creditor. It is not someone's estimate of what we might spend based on a host of assumptions about future policy and economic conditions.

Exhibit 1: Total US Federal Debt by Holder

Source: US Department of the Treasury, as of 12/31/11.

Is the US's debt load historically high?

Once debt has been accounted for properly (net debt), how can we tell if it's high? By putting it in scale relative to the size of the US economy. As of 2/28/2012, US federal net debt was about 69.9% of GDP. That's higher than the historical average, but still well below previous peak levels (see Exhibit 2). And the period following that elevated debt wasn't known for being a period of great economic distress. Rather, the late 1940s and 1950s were overall economically vibrant.

Many don't realize that from 1750 to 1850, Great Britain-the era's global economic powerhouse-had a debt-to-GDP ratio over 100%, peaking above 250%! This period included Britain's Industrial Revolution-the UK was the center of transformative technological advances globally. Folks often say our debt is "too high," but there doesn't seem to be historical evidence of a definitive level at which developed nations implode or face economic ruin.

Exhibit 2: Net Public Debt as a Percentage of GDP

Source: Office of Management and Budget, US Department of the Treasury, Bureau of Economic Analysis, as of 2/22/2012.

What about debt service payments-are they too high?

The key issue when considering debt shouldn't be the absolute amount, but the relative affordability. Thanks to interest rates being relatively benign, interest payments on federal debt are currently about 2% of GDP (as of 12/31/2011). In fact, from roughly 1979 through the first quarter of 2003, US debt levels relative to GDP were lower, but interest payments were higher than now. During much of the 1980s and 1990s-debt interest payments were nearly double today's levels. Which makes it difficult to argue today's debt service costs are inherently problematic or likely to impoverish future generations.

Exhibit 3: Federal Debt Interest Payments as a Percent of GDP

Source: Thomson Reuters (Q1 1952-Q3 2011).

Did losing AAA status hurt the US?

Interest rates on 10-year Treasurys actually fell in the immediate wake of S&P's downgrade and remain near historically low levels, so it doesn't seem the downgrade negatively impacted our debt much at all. US debt is still seen as a global safe haven because it's bolstered by the size and strength of the US economy (the largest single economy in the world, as well as being very diversified) and is combined with a stable political landscape and deep, liquid financial markets.

Exhibit 4:10-Year US Treasury Yield

Source: Global Financial Data, Inc.; as of 11/29/11.

In summary, though current debt levels may seem massive in absolute terms, they don't signal an inherently problematic level when viewed in scale and in context. Ultimately, Americans have feared our national debt nearly as long as there's been national debt. That fear of debt-and the heated political rhetoric around it-likely never evaporates. But rationally understanding the US debt situation can help investors avoid from making rash decisions based on incomplete or incorrect assumptions.