The Dangers of Debt
by Dr. Doug Cardell
Why should we care about the national debt? Let's see if we can put it in more personal terms. The national debt is mainly unsecured debt. That is, it is debt not backed by assets. In personal terms, your home loan and your vehicle loan are examples of secured debt; they are backed by collateral, your home, and your car. Most economists agree that borrowing to finance infrastructure is like a home loan; you get physical assets in return for the money, and these assets increase productivity, producing more revenue. Personal, unsecured debt is credit card balances, student loans, and signature loans. Unsecured loans, like most US debt, typically carry higher interest rates because the lender is taking a more considerable risk. How much debt is too much? That's a question that we can't answer without knowing about income. Is $100,000 in debt too much? First, is the debt secured or unsecured? A $400,000 home loan on a home valued at $500,000 is acceptable since if the owner can't repay the loan, the owner can sell the house for a $100,000 profit and pay off the loan. The usual rule of thumb for home purchases says you can afford a home loan equal to two years of income. That brings up the income issue. The national income is measured by the Gross Domestic Product (GDP). The GDP is the value of all goods and services produced in the United States per year, just as your income is the value of all goods and services you produce yearly. Is $100,000 in unsecured credit card debt too much? Well, if your annual production pays you a million dollars per year, no, $100,000 is reasonable. You're in trouble if your annual production earns you $100,000 annually. Less than that, and you're in deep, deep trouble. Why? Because what matters is your debt-to-income ratio. That is, you take your total unsecured debt and divide it by your annual income. That number is your debt-to-income ratio. Usually, it is multiplied by 100 and written as a percentage. In the first example, credit card debt of $100,000 against an income of one million annually yields a debt-to-income ratio of 10%. That's not a problem. In the second example, $100,000 in debt compared to $100,000 in income gives us a debt-to-income ratio of 100%. That's a huge problem. At that level, it will be difficult, if not impossible, to pay even the interest on the debt, let alone reduce the principal. What is an acceptable debt-income ratio? Most banks won't lend you money if your secured and unsecured ratio exceeds 50% or if your unsecured ratio is above 25%. How does that apply to the national debt? Today, in March 2024, the national debt is 34.1 trillion dollars. You can see the exact amount right now here: 'US Debt Clock'. The national debt is primarily unsecured debt, like credit card debt. Is that too much? By now, you know it depends on income and GDP. Today, the GDP is 28 trillion. Therefore the debt to GDP ratio is 1.22 or 122%. That's a big problem. Why do lenders lend to the US if their unsecured debt ratio is so high? Because over time, when the ratio was much lower, the US developed an excellent credit rating. But that is changing. Investors are beginning to worry that the US's good credit is a thing of the past. Governments have three ways to address debt at this level. One is to spend at a lower level and pay down the debt. One way is to raise GDP, usually by population growth; more people produce more products and services, assuming they are employed. And the third way is by inflation. When inflation is high, the value of money decreases, meaning that you're paying back the debt with dollars worth less than the money you borrowed. It is rare for the government to address the problem by spending less. In the last 100 years, it has only happened once, when Republican Newt Gingrich and Democrat Bill Clinton worked together to create a budget that eliminated deficit spending for eight years from 1992 to 2000. For most of the twentieth century, the budget deficits were small and usually only during wartime. In the twenty-first century, the government began trying to correct recessions and the COVID pandemic with massive government spending of borrowed money. This was never done in the twentieth century, not even during the Great Depression. To make matters worse, the spending has never returned to pre-emergency levels.
The graph above shows the national debt as a percent of GDP. For most of the twentieth century, it was below 40%. Notice that from 2000 to 2008, the ratio stayed at about 60% despite a recession and the Gulf War. The response to the 2008 recession created the steepest increase in debt in US history thus far and was never corrected after the emergency ended. Then, the COVID pandemic created an even more rapid increase. After the emergency ended, the debt-to-GDP ratio decreased somewhat. The green line in the graph shows what should have happened, but the projections indicate that the red line is the more likely outcome. The government policy is to use more borrowing to address the problems caused by borrowing, much like using one credit card to pay off another and increasing total debt. Why is the rising national debt so destructive? Because eventually, it leads to default, which is the personal equivalent of bankruptcy. When that happens, the government's credit rating tanks and makes further borrowing impossible. That means dramatic cuts in spending that create extreme hardship for the population or huge tax increases that also cause extreme hardship. It would also damage the world economy for decades, which is why the rest of the world is nearing panic about our growing debt. If we don't reduce the debt, there will be pain ahead for everyone. In closing, I'll use the same paragraph I did in 'Debt Limit'. In the long run, Congress should reset the budget process so that each year's budget can only spend last year's revenue. We should hold the government to the same standard as wise citizens. It should limit spending based on income rather than debt limit. Without action to correct the situation, Congress and the White House will replay this identical drama yearly until the country is bankrupt and suffers a complete financial collapse. That means far fewer jobs, more empty store shelves, and prices so high that what is on the shelves is unaffordable.
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