What Trump and Other Pessimists Don’t Understand About U.S. Debt
Interest-Rates / US Debt Oct 08, 2015 - 08:17 PM GMTBy: Investment_U
Alexander Green writes:I received still more blowback from my last few columns about Donald Trump and the economic pessimists.
Some readers are in no mood to hear anything positive about the state of the country or our current economic situation.
Others realize that the economy is growing, the dollar is strong, inflation is low, American corporations are reporting record profits and U.S. household net worth just hit an all-time high.
But they believe these factors are “trumped” by a huge and growing federal debt that has us on the brink of national collapse.
This sort of thing gets repeated so often that many no longer stop to consider whether it’s true. Yes, the federal debt is a serious problem. But we are not on the verge of national bankruptcy.
Not even close. Here’s why.
At $18.4 trillion, the national debt is stupendous. When the astronomer Carl Sagan was alive, he often talked about the billions of galaxies in the universe, each filled with hundreds of billions of stars.
Today we have politicians in Washington throwing around numbers - trillions - that even astronomers won’t touch. That’s not good.
But here’s the essential point: Debt is meaningless except in relation to income and assets.
Here’s an example. If you were carrying $60 million in debt, you might have a few sleepless nights. But Bill Gates wouldn’t lose a wink. Why? Because he’s worth $79.2 billion. Sixty million dollars is less than one-tenth of 1% of his net worth.
He could leave it in his jacket pocket and forget about it. The sum isn’t meaningful in relation to his total assets.
Here’s another example. Fifty-one years ago, my dad made a bold financial move. He needed a new home for his growing family of six, so he decided to take out - hold your breath - a thirty-thousand-dollar mortgage.
Well, ok, having the courage to take out a mortgage that size today wouldn’t qualify you for the Congressional Medal of Honor. But at the time, he earned only $28,000 a year. My dad borrowed a sum larger than his annual income. (Just as many other homeowners do.)
Over time, the mortgage amount and monthly payment became trivial, thanks to inflation and his growing income.
Still, he took a risk. His earnings could have declined. If so, the mortgage would have been harder - and perhaps impossible - to service.
Let’s turn again to the federal deficit. It’s inexcusable. Politicians on both sides of the aisle have spent recklessly for years - and especially outdone themselves during the tenure of George W. Bush and Barack Obama.
However, we do have an $18.1 trillion economy. Just as my dad’s mortgage was somewhat larger than his income, our federal debt is slightly larger than our GDP.
I’m not any happier about this than you are. But the situation is manageable, especially since things are getting a little better.
The Congressional Budget Office announced two weeks ago that this year’s federal deficit will be $426 billion. That is the lowest deficit in seven years and well below the five-year string of $1 trillion-plus annual deficits.
Why is the budget deficit lower? Stronger economic growth, higher tax revenue and the sequester, a set of automatic budget cuts that kick in when Republicans and Democrats can’t agree.
In short, the annual deficit is becoming less of a problem - not more of one.
Like my dad’s mortgage in 1964, it is sizable but unlikely to bankrupt us anytime soon. Inflation and a growing economy will chip away at it over time. It will take fiscal responsibility too. My dad didn’t take out second and third mortgages.
Uncle Sam has a couple other advantages. For starters, my dad couldn’t borrow money for 30 years at 2.9%, the current yield on 30-year Treasurys. He also couldn’t crank up a printing press in the basement if he found himself a little short.
Also, my dad repaid the entire principal amount. The U.S. government will not do that in our lifetimes, if ever.
If the debt as a percentage of GDP continues to shrink, it will become less of a threat to future prosperity. If the opposite happens and politicians in Washington can’t get their stuff together, that’s a different story.
However, just as a $30,000 mortgage looks minuscule today, so will our $18.4 trillion debt in 30 years, provided our elected representatives begin acting responsibly.
You may be skeptical on this point. I talk to pessimists every day who believe Congress will pull a Thelma & Louise and just barrel over the cliff.
That’s unlikely, however, because it violates one of the first laws of finance: As money gets scarcer, people get smarter.
The bipartisan Simpson-Bowles commission showed that the debt can be fixed with principled compromise. Too bad Obama completely ignored its advice.
That doesn’t mean everyone else will in the future, however.
Understand this and it becomes clear why the U.S. economy isn’t imploding, the dollar isn’t tanking and the stock market isn’t crashing.
Good investing,
Alex
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