{"id":14729,"date":"2024-06-26T16:44:44","date_gmt":"2024-06-26T20:44:44","guid":{"rendered":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/?p=14729"},"modified":"2024-06-26T16:44:45","modified_gmt":"2024-06-26T20:44:45","slug":"us-debt-dilemma-no-quick-fixes-and-no-catastrophes","status":"publish","type":"post","link":"https:\/\/www.rbcwealthmanagement.com\/en-eu\/insights\/us-debt-dilemma-no-quick-fixes-and-no-catastrophes","title":{"rendered":"U.S. debt dilemma: No quick fixes and no catastrophes"},"content":{"rendered":"\n<p><strong>By Atul Bhatia, CFA<\/strong><\/p>\n\n\n\n<div class=\"well b-blue-tint-4 mb-3\">\n      <ul class=\"list-spaced\">\n        <li>\n          U.S. government debt has been rising rapidly since the global\n          financial crisis, but broader measures of borrowing across the economy\n          have remained relatively stable and on par with other developed\n          economies.\n        <\/li>\n        <li>\n          U.S. fiscal policy is likely already unsustainable, with politically\n          sensitive programs costing more than current taxes generate.\n        <\/li>\n        <li>\n          Higher inflation \u2013 not default or foreign coercion \u2013 is the likely trigger\n          for the U.S. to put its budgetary house in order.\n        <\/li>\n      <\/ul>\n    <\/div>\n    \n    <!-- body -->\n    <p>\n      The U.S. debt has always been a divisive matter. Not only is there\n      disagreement on its causes and fixes, but no one can seem to agree if, or\n      when, the federal debt becomes a concern.\n    <\/p>\n    <p>\n      Both sides of the argument have a problem, in our view. Folks saying that\n      the amount of U.S. borrowing will lead to a calamity have to deal with a\n      40-year track record of being wrong, the counter-example of the Japanese\n      economy functioning with debt levels nearly twice that of the U.S. today,\n      and the fact that no sovereign has defaulted when borrowings are\n      exclusively in its own fiat currency under its own law.\n    <\/p>\n    <p>\n      For those saying the debt is irrelevant, the path is no easier. The major\n      stumbling block is the apparent absurdity of their argument: somehow,\n      somewhere it must matter how much money we have borrowed to fund our\n      current spending. After all, \u201cthere is no such thing as a free lunch\u201d is\n      not a bad starting premise for the study of economics.\n    <\/p>\n    <p>\n      Our view is between these two extremes. We believe the federal debt \u2013 in and\n      of itself \u2013 is a manageable concern and that the U.S. is nowhere near a\n      default risk. At the same time, we think that the conditions that created\n      the debt \u2013 which are ongoing \u2013 are problematic and will impose future costs on\n      the economy.\n    <\/p>\n    \n    <!-- section -->\n    <h2>Got debt? Sort of<\/h2>\n    <p>\n      Before turning to fiscal policy, which we see as the real issue, it\u2019s\n      worth diving into the federal debt given how much press it gets. And it\n      gets that level of attention for good reason \u2013 the federal government owes a\n      gob smacking amount of money. Even without considering the debt to various\n      government trust funds, the Treasury has borrowed nearly $28 trillion\n      dollars, or just under 100 percent of Gross Domestic Product (GDP). If Social\n      Security and similar obligations are included, the total is easily above\n      $33 trillion. Statistics like these seem to lend credence to the view that\n      U.S. debt is out of control.\n    <\/p>\n    <p>\n      What\u2019s odd to us, though, is the laser-like focus on the federal\n      government\u2019s borrowing. After all, most economic activity in the U.S.\n      takes place outside the government and is instead the product of corporate\n      and household activity. When we broaden out our perspective to include\n      these sectors, the debt position of the U.S. as a country \u2013 not just a\n      government \u2013 looks very different.\n    <\/p>\n    <p>\n      First, there has been no appreciable recent run-up in national borrowing.\n      Aside from a COVID-19-related blip, the overall debt-to-GDP ratio has been\n      remarkably stable over the past 15 years. There have certainly been\n      changes in the composition of U.S. borrowing, but the amount of debt has\n      grown at roughly the same pace as the economy overall for over a decade.\n    <\/p>\n    \n    <!-- ex 1 -->\n    <h3>Far from exploding, U.S. debt has been boringly consistent for 15 years<\/h3>\n    <h4>Total nonfinancial debt as percentage of U.S. GDP<\/h4>\n    <div class=\"row mb-4\">\n      <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">\n        <img decoding=\"async\"\n          src=\"https:\/\/www.rbcwealthmanagement.com\/assets\/wp-content\/uploads\/global\/us-budget-dilemma-en-chart-1.png\"\n          alt=\"Total nonfinancial debt as percentage of U.S. GDP\"\n          class=\"img-fluid mb-1-half\"\n          aria-describedby=\"chart1desc\"\n        \/>\n        <p class=\"sr-only\" id=\"chart1desc\">\n          The chart shows total U.S. nonfinancial debt as a percentage of gross domestic product (GDP) quarterly from 2010 through 2023. Debt is broken down into four categories: (1) households and nonprofits; (2) nonfinancial businesses; (3) the federal government; (4) state and local governments. Together, these categories totaled roughly 249 percent of GDP in 2010 and roughly 265 percent of GDP at the end of 2023. The relative proportions of each category have been generally stable over the period shown. All categories showed a sharp rise in 2020 and a subsequent decrease, although federal debt has remained elevated relative to its historical level. \n        <\/p>\n        <ul class=\"rbc-legend rbc-legend-inline\">\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-dark-blue-tint-1\"><\/div>\n            Households and nonprofits\n          <\/li>\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-warm-yellow\"><\/div>\n           Federal government\n          <\/li>\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-apple\"><\/div>\n            Nonfinancial businesses\n          <\/li>\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-tundra\"><\/div>\n            State and local governments\n          <\/li>\n        <\/ul>\n        <p class=\"disclaimer\">Source &#8211; U.S. Federal Reserve; quarterly data through 2023<\/p>\n      <\/div>\n    <\/div>\n    \n    <p>\n      Nor does the U.S. debt burden look particularly troublesome compared to\n      other large, developed countries. The combined debt load across U.S.\n      corporations, households, and government entities was around 260 percent at the\n      end of 2022, the last year for which International Monetary Fund stats are\n      available. This puts the U.S. essentially at the median debt level for\n      large, developed economies.\n    <\/p>\n    <p>\n      Put differently, if the U.S. were to dedicate its entire annual production\n      to debt repayment, it would take about 2.6 years to wipe out all the money\n      that households, businesses, and government entities have borrowed. That\u2019s\n      essentially the same timeline faced by the UK or Sweden, and it\u2019s\n      substantially less than Canada, where every dollar of productivity\n      capacity has the burden of more than $3 of debt outstanding.\n    <\/p>\n    <p>\n      In fact, when we look at U.S. borrowing, what stands out to us is not the\n      amount but the composition of its debt. More than most other countries,\n      it\u2019s the federal government that has borrowed against national assets, not\n      private individuals or businesses.\n    <\/p>\n    \n    <!-- ex 2 -->\n    <h3>A broader measure of indebtedness shows the U.S. is fairly typical<\/h3>\n    <h4>Debt as percentage of 2022 national GDP<\/h4>\n    <div class=\"row mb-4\">\n      <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">\n        <img decoding=\"async\"\n          src=\"https:\/\/www.rbcwealthmanagement.com\/assets\/wp-content\/uploads\/global\/us-budget-dilemma-en-chart-2.png\"\n          alt=\"Debt as percentage of 2022 national GDP\"\n          class=\"img-fluid mb-1-half\"\n          aria-describedby=\"chart2desc\"\n        \/>\n        <p class=\"sr-only\" id=\"chart2desc\">\n          The column chart shows debt in 2022 as a percentage of national gross domestic product (GDP) for eight countries (ordered from least to most total debt): Germany (194 percent of GDP), Ireland (219 percent), the United Kingdom (252 percent), Italy (254 percent), China (272 percent), the United States (273 percent), Sweden (274 percent), and Canada (322 percent). Debt is broken down into categories of general government debt, household debt, and nonfinancial corporate debt. \n        <\/p>\n        <ul class=\"rbc-legend rbc-legend-inline\">\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-dark-blue-tint-1\"><\/div>\n            General government\n          <\/li>\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-warm-yellow\"><\/div>\n            Household debt\n          <\/li>\n          <li class=\"rbc-legend-item\">\n            <div class=\"rbc-legend-bar c-tundra\"><\/div>\n            Nonfinancial corporate debt\n          <\/li>\n        <\/ul>\n        <p class=\"disclaimer\">Source &#8211; International Monetary Fund; includes bonds, loans, and debt securities<\/p>\n      <\/div>\n    <\/div>\n    \n    <p>There\u2019s a lot to like, we think, about that debt profile.<\/p>\n    <p>\n      To start, it\u2019s the cheapest way to borrow. As a nation, the U.S. dedicates\n      fewer resources to financing costs than if households or businesses had\n      taken on loans. In addition, the federal government is not \u2013 yet \u2013 forced to\n      belt-tighten when interest rates move up. This is different from, say,\n      Canadian households that are feeling the pinch from higher mortgage costs,\n      with negative, economy-wide implications.\n    <\/p>\n    <p>\n      Viewed across the entire economy, the U.S. has constructed a borrowing\n      profile that is reasonable for the size of its economy and has a\n      relatively advantageous borrowing structure, in our view. Far from being\n      an albatross, federal debt is a potential advantage relative to the\n      alternative of household or corporate leverage.\n    <\/p>\n    \n    <!-- section -->\n    <h2>At least drunken sailors pay cash<\/h2>\n    <p>\n      While we believe that the federal government is the best positioned entity\n      to carry a high debt burden, it is perhaps the worst entity at deciding\n      whether additional borrowing is worthwhile. Households and corporations\n      typically have a plan on how to repay any new borrowing, if only because\n      lenders demand one. The federal government, by contrast, is never asked\n      for a long-term repayment plan \u2013 not by bond buyers or voters.\n    <\/p>\n    <p>\n      It\u2019s important to be clear that the debt is not a partisan creation.\n      Politicians of all stripes pay lip service to fiscal restraint, but when\n      in office both parties keep taxes well below the level of spending.\n    <\/p>\n    <p>\n      Part of the reason is voting math. Since at least the 1980s, there have\n      been a few budget items that are electoral third rails \u2013 touching them is\n      political death: The big three are Social Security; Medicare\/Medicaid;\n      and, to a lesser extent, defense. Combined, these \u201cmust fund\u201d activities\n      now exceed the federal government\u2019s tax receipts. Interest expense on\n      existing debt is an increasingly important addition to this required\n      annual outflow.\n    <\/p>\n    \n    <!-- ex 3 -->\n    <h3>When uncuttable spending meets unraisable taxes, the budget math\n      can\u2019t add up<\/h3>\n    <h4>2023 U.S. revenue and expenditures by budget category ($ billions)<\/h4>\n    <div class=\"row mb-4\">\n      <div class=\"col-lg-10 col-md-8 col-sm-8 col-xs-10 col-xxs-12\">\n        <img decoding=\"async\"\n          src=\"https:\/\/www.rbcwealthmanagement.com\/assets\/wp-content\/uploads\/global\/us-budget-dilemma-en-chart-3.png\"\n          alt=\"2023 U.S. revenue and expenditures by budget category\"\n          class=\"img-fluid mb-1-half\"\n          aria-describedby=\"chart3desc\"\n        \/>\n        <p class=\"sr-only\" id=\"chart3desc\">\n          The chart shows the disposition of U.S. tax receipts by budget category for fiscal year 2023. Starting with tax receipts of $4,440 billion, $2,594 billion is subtracted for Medicare and health, $1,438 billion for Social Security, $1,297 billion for national defense, and $905 billion for net interest payments, resulting in a negative balance of $1,794 billion. \n        <\/p>\n        <p class=\"disclaimer\">Source &#8211; U.S. Treasury Department, RBC Wealth Management; data for fiscal year 2023<\/p>\n      <\/div>\n    <\/div>\n    \n    <p>\n      Against that backdrop, we think it\u2019s almost a given that the debt is going\n      to continue to grow for the foreseeable future. In our view, it\u2019s\n      unrealistic to expect politicians to meaningfully raise taxes or cut\n      popular programs without some sort of external impetus.\n    <\/p>\n    <p>\n      In theory, that could come from the electorate. Survey data shows a high\n      degree of voter concern on the federal debt. When asked, however, about\n      their willingness to accept higher personal taxes or reduced benefits,\n      voters quickly change their tune. Support for debt reduction only lasts as\n      long as someone else pays. Politics is the art of the possible, and\n      balancing the budget without shared sacrifice strikes us as effectively\n      impossible.\n    <\/p>\n    \n    <!-- section -->\n    <h2>You want us in that mall, you need us in that mall<\/h2>\n    <p>\n      An alternate argument is that lenders will prompt fiscal retrenchment by\n      pulling back from Treasury bonds. We see that as extremely unlikely.\n    <\/p>\n    <p>\n      In our view, simple self-interest decides the issue. The U.S. is the\n      world\u2019s consumer, and both foreign and domestic producers need Americans\n      to buy their products. Even those companies that don\u2019t directly sell in\n      the country would almost certainly feel the impact of a U.S. economic\n      contraction.\n    <\/p>\n    <p>\n      The current level of U.S. consumption is only possible because of credit,\n      and it is in the producers\u2019 self-interest to recycle at least some of\n      their earnings into continued lending.\n    <\/p>\n    <p>\n      The dynamic is easiest to see when looking at overseas actors. Foreign\n      countries often buy U.S. dollars to gain a currency advantage for their\n      exports, which results in a need to invest those dollars in low-risk\n      assets such as Treasury bonds. Those bond purchases then give the U.S.\n      government the needed resources to continue spending beyond its means.\n    <\/p>\n    <p>\n      Another way to think about the lending\/selling dynamic is to look at the\n      history of the car industry. The rise of the automobile finance\n      corporation did not come about because car manufacturers were drawn to the\n      consumer loan business; it was instead the realisation that without\n      credit, car demand evaporated and the producer, ultimately, suffered.\n    <\/p>\n    \n    <!-- section -->\n    <h2>Not with a bang but a whimper<\/h2>\n    <p>\n      Our view, then, is that we should expect the budget deficit to remain and\n      probably grow, with federal debt increasing for the foreseeable future.\n    <\/p>\n    <p>\n      The process will inevitably end, and we see the inflationary impact of\n      budget deficits as the most likely catalyst for change. Put simply, when\n      the U.S. government spends more than it taxes, it adds to near-term\n      demand, which is likely to be inflationary.\n    <\/p>\n    <p>\n      For the past several decades, the potential price consequences of\n      government borrowing were, we believe, largely offset by other factors:\n      growing low-cost supply from China, the deflationary consequences of the\n      global financial crisis, and declines in household borrowing. These\n      factors, we believe, are largely played out, potentially leading to more\n      visible inflation from deficit financing.\n    <\/p>\n    <p>\n      That, we think, is good news for fiscal rationality. One of the key\n      takeaways from the past two years, we would argue, is that inflation is\n      intolerable across most sectors of U.S. society. While we think it\u2019s a\n      utopian belief that voters will wake up one day and decide to belt-tighten\n      to help their grandchildren, we see a relatively easy link between rising\n      prices and consumer anger.\n    <\/p>\n    <p>\n      Regardless of what sparks the shift toward fiscal balance, our view is\n      that the resolution is likely to be painful, but manageable. It will\n      almost certainly come from a combination of cutting government spending\n      and benefits, increasing taxes, and allowing higher inflation to reduce\n      some of the real cost of repayment. The outcome of these adjustments is\n      very likely to be negative for global growth, creating a headwind for all\n      sectors of society, including workers, taxpayers, and investors.\n    <\/p>\n    <p>\n      In essence, we are saying that neither households nor corporations are\n      quite as well-off today as they think they are. At a certain point, some\n      of what is currently private wealth will need to be used to pay down\n      national borrowings. That process will be a headwind for prosperity, and\n      one that grows in strength every year, but it is also part of the normal\n      cycles of change in a dynamic economy. After all, government borrowing\n      taking place today is helping create private wealth through economic\n      growth and investment gains.\n    <\/p>\n    \n    <!-- section -->\n    <h2>Reasons for optimism<\/h2>\n    <p>\n      \u201cPredictions,\u201d according to a Danish proverb, \u201care difficult, especially\n      about the future.\u201d The further in advance, the larger the likely error.\n      \u201cCatastrophising\u201d over long-term debt estimates ignores this reality and\n      the history of prior failed projections.\n    <\/p>\n    <p>\n      Take the 2010s, for instance. If there was a prevailing theme to budget\n      discussions at that time, it was rising healthcare costs and how Medicare\n      spending would pressure the U.S. Treasury beyond control. Fast forward 10\n      years and Medicare costs per beneficiary were stable for a decade. The\n      root causes of the improvement are still debated, but the beneficial\n      financial consequences amount to nearly $4 trillion since 2011, according\n      to an analysis published in Health Affairs.\n    <\/p>\n    <p>\n      Artificial intelligence (AI) and technology in general are obvious\n      potential positive factors for the federal budget, in our opinion. The\n      impact is two-fold, with rising prosperity increasing tax contributions\n      and more efficient, technology-enabled operations reducing costs. Just as\n      the internet helped transform the provision of government services, we\n      think it would be foolish to rule out the possibility of an AI-induced\n      budget fillip.\n    <\/p>\n    <p>\n      The simple reality is that not all uncertain outcomes turn out to be\n      unfavourable.\n    <\/p>\n    \n    <!-- section -->\n    <h2>Extreme outcomes extremely unlikely<\/h2>\n    <p>\n      Our view of high debt creating future growth headwinds is common in\n      economic textbooks, but less frequently found in the popular press, who\n      instead put forward theories of a bankrupt Treasury failing to make\n      payments or the risk of China using its bond holdings to exert influence\n      or control over U.S. policy.\n    <\/p>\n    <p>\n      We think these risks are vastly overstated and overlook three key\n      realities.\n    <\/p>\n    <p>\n      First, the federal government is not a typical borrower. Its debt is\n      issued in its own currency under its own law, giving it debt management\n      tools such as taxing interest payments or forcing the Fed to buy bonds\n      through money printing. These are not costless \u2013 they would come with\n      inflation or difficulty selling bonds in the future \u2013 but they\u2019re not even\n      on the table for other debtors.\n    <\/p>\n    <p>\n      Second, a U.S. default would be a global economic catastrophe. There were\n      $600 billion in subprime mortgages outstanding in 2006, and they managed\n      to throw the global economy into a recession that took years for recovery;\n      Treasuries have nearly 50x that amount outstanding. A U.S. default would\n      almost inevitably throw the U.S. and the world into a severe recession and\n      eviscerate bank capital globally. There would be, in our view, no winners,\n      only varying degrees of losing.\n    <\/p>\n    <p>\n      Third, default is not currently a viable option for creditors. U.S.\n      solvency is not an immutable law of nature; we accept that default is a\n      possibility. But for a default to be a realistic alternative, there would\n      have to be sufficient non-U.S. demand to allow for a deep and severe U.S.\n      recession without it tipping into a global recession. In addition, there\n      would have to be an asset that replaces Treasuries as the dominant source\n      of inter-bank collateral. Until that happens, we think creditor\n      self-interest argues against a default.\n    <\/p>\n    <p>\n      For these reasons, we also reject the idea that China \u2013 or any other\n      nation \u2013 can realistically use its bond holdings for geopolitical advantage.\n      It would be economically disastrous for whatever nation pulled its cash,\n      and it would be unlikely to work in practice, as the U.S. can legally use\n      its sovereign authority to cushion any blow.\n    <\/p>\n    <p>\n      More fundamentally, we think this argument reverses where power lies in\n      the lending relationship. The U.S. has already received goods and services\n      from China and paid for them with over a trillion dollars in IOUs. China,\n      we would argue, is the one exposed to geopolitical risk in this scenario,\n      not vice versa.\n    <\/p>\n    \n    <!-- section -->\n    <h2>Debate, discussion, and debt<\/h2>\n    <p>\n      The so-called debate on the federal debt often seems to be a choice\n      between hyperbolic claims of imminent collapse and a Panglossian view that\n      no matter the amount, the debt is not a concern.\n    <\/p>\n    <p>\n      We believe that is a false dichotomy. In our view, the current level of\n      debt will not lead to a default but will likely impose eventual economic\n      costs in the form of lower growth, reduced government benefits, higher\n      taxes, and higher inflation. If, as we project, deficits continue and the\n      debt burden grows, then the eventual resolution will take longer and weigh\n      more on the economy than if it were addressed sooner.\n    <\/p>\n","protected":false},"excerpt":{"rendered":"<p>The federal government\u2019s debt has doubled since 2015 \u2013 and shows no signs of turning around.<\/p>\n","protected":false},"author":15,"featured_media":14730,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"rbcwm_post_date":"2024-06-26T11:54:46","editor_notices":[],"rbc_url_alias":"","rbcwm_featured_desktop_image_position":"","rbcwm_featured_mobile_image_position":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[80],"tags":[],"rbcwm_content_owner":[506],"rbcwm_need":[],"rbcwm_segment":[],"rbcwm_solution":[],"rbcwm_topic":[81],"rbcwm_channel":[],"rbcwm_format":[],"class_list":["post-14729","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-analysis","rbcwm_content_owner-pag","rbcwm_topic-global-insights"],"acf":{"rbcwm_subtitle":"The federal government\u2019s debt has doubled since 2015 \u2013 and shows no signs of turning 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