It’s a milestone anniversary: 75 years since the end of World War II, our emergence as the dominant global economic power, and the last time our national debt was actually greater than the value of our productivity, as measured by our debt-to-GDP (gross domestic product) ratio.
This relative measure is more useful than an absolute, since our national debt can be useful as long as our productivity can support it. Recently, projections by the Congressional Budget Office have us crossing this Rubicon once again, with the national debt expected to hit 104 percent of GDP by October 2021.
In 1945 our debt was war debt, borrowed to arm ourselves and our allies. This was historically the case with the relative size of our federal debt up until that time: it expanded during wartime and shrank during peacetime. Wars create an urgency that trumps fiscal policy, so we borrow.
In 1945, the rest of the world’s productivity was shattered, and it was a generation before we had real competition again. Given that unchallenged dominance, our productivity grew and our relative debt quickly shrank and stayed low, even with the expansion of government spending on the arms race, the space race, Vietnam, Medicare, and the Great Society.
The relative size of our debt started to rise again in the 1980s and, with the exception of a dip in 2000, has risen steadily ever since. The economy has grown, but government spending has increased faster, as we waged perpetual war and weathered the Great Recession. At the same time, we have steadily lowered tax rates, forcing more reliance on debt. And the pandemic has only accelerated that dynamic, with its urgent need for broad fiscal supports and its shutdown of economic activity, finally pushing our debt beyond our productivity.
Federal debt can get costly, especially if interest rates rise. Surely, the amount of interest we pay on the current debt could be better spent: in 2018, interest expense was nearly 8 percent of the federal budget. Yet interest rates are almost at zero and have been since the financial crisis of 2008, and will be, as the Federal Reserve has announced that it will continue a policy of easing to help support the economy through this virus-induced recession.
Public debt can flood the debt markets with government bonds, pulling down bond prices and pushing up interest rates. This can make debt more expensive for everyone else, dampen corporate and individual access to borrowing, and spark inflation as interest rates rise. But investors are buying up the government’s debt for its relative security, keeping interest cheap, so corporate and consumer borrowing can continue. And we haven’t seen meaningful inflation since the 1980s, and given the Fed’s policy of prolonged easing, we probably won’t for the foreseeable future.
Debt can make us beholden to creditors, yet most of our debt (71 percent) is owed to ourselves: to other government agencies (27 percent) such as the Social Security Administration, to the Federal Reserve (12 percent), which began buying up Treasury bonds in 2008 and has never stopped, and to other domestic creditors (32 percent) such as pension funds and mutual funds. Foreign ownership is only about 29 percent of the total and given global economic interdependence and their own need for relatively safe investments, our foreign competitors have little to gain by using our debt to their competitive advantage.
So, if we need not fear the cost of debt, or rising inflation, or foreign creditors, is the milestone even of note? It is, if only to remind us of how little it seems to matter. For centuries now, in the modern age of finance, debt has been a bellwether of economic health and potential, every country’s or individual’s economic canary. Too much debt has been seen, at best, as a hindrance to potential growth, a drag on income and security, and at worst, the first step on the road to ruin.
If productivity growth can resume and continue, it will begin to offset the relative size of the debt, and this ratio will again recede. Besides, the pandemic creates an urgency that trumps fiscal policy, and there are no good alternatives but to support the economy with federal spending until we can resume full activities. And so, at least in the near term, we have no choice but to borrow.
But if individual, corporate, and even municipal and state bankruptcies accelerate, there will be other consequences, now unforeseen. Maybe then we will learn to look at debt, and its use and usefulness, differently.