Economics and Finance, Presidential

“A National Blessing”: Some Thoughts on Our Debt

“I love debt.” Like you ‘love’ Hispanics?

Here’s the thing: by being out of the country, I’m hoping to not hear or see much of Donald Trump, or any other ridiculous charades going on for election 2016. That said, so long as I want to read some news, so long as I meet other travelers and locals, so long as I have an internet connection, I’m going to hear something about Mr. Trump. And on top of that, he keeps saying interesting things, like this gem.

oh_jesus

What I do appreciate about Donald Trump, genuinely, is that he brings up issues that often drop out of the spotlight, even if most of the time he’s flat-out wrong and is putting out misinformation (which most of the media quickly jumps to correct). Take the national debt:

Donald Trump raised a ruckus with his comments about the national debt last week, when the presumptive Republican presidential nominee seemed to suggest that the U.S. government might not pay all of what it owes. Bonds issued by the Treasury Department are considered some of the most dependable securities in the world, and if a future Trump administration didn’t honor them, the consequences for the global economy could be disastrous.

Then he sort of backtracked, saying he was not suggesting a default.

First, Trump explained — correctly — that because the U.S. government prints its own currency, the country should never have to default on its debt. The government can print more money to repay the debts, which would cause inflation but not a default… Then, Trump went on to suggest that the Treasury could somehow repurchase bonds that are currently in circulation, effectively paying back the debt early.

My perspective on the U.S. national debt has shifted over the last few years as I learned more about it and its functioning in the global economy. So here are my two cents, in bullet points:

  • The U.S. Treasury security is easily the most important financial instrument in the world. In times of stress, investors flock to Treasury bonds because they are safe.
  • I suppose there are a few different reasons for Treasuries’ safety.
    • One is that the U.S. government has never defaulted (fingers crossed!) and is thus a reliable borrower, giving it a strong credit rating (AA-).
    • Another is that, except in times like the 2011 debt ceiling episode, there is no expectation that the government will default, based on its projected revenue (taxes, etc.) and obligations, though that could change in the long term.
    • A third is that the government is stable–our government of course has not changed its basic structure since 1789, whereas, say, a country undergoing a revolution of some kind might see the interest on its bonds spike. Finally, the debt is a sovereign bond denominated in dollars, which is a stable and systemically important currency.
  • Having a large debt isn’t necessarily bad, and in fact, it might actually be good. One thing I noticed is how much various investors all need Treasury debt. It’s an important reason to be good stewards of the debt we issue.
    • Individuals need a safe asset for a stable source of income (interest).
    • Private firms in the market need Treasuries in their portfolios for safety and to satisfy some Dodd-Frank regulations.
    • Foreign central banks, like those of China and Japan, need Treasury securities for their own operations, while our central bank, the Fed, needs them to perform open market operations and provide stimulus to the economy. Without a large supply of Treasuries, QE would have been logistically much more difficult.
  • A large debt also enables our government to do things it couldn’t do otherwise. Think of any major projects, like defense research projects that lead to the internet and spaceplanes, or like improvements to infrastructure. The same way a credit line or mortgage allows you to invest in a new car or house.
  • U.S. government debt is special. It is the “risk-free” asset of the financial market–that is, the rate on any other debt is generally going to have a positive spread (a higher rate): a bank loan, a student loan, a mortgage.
  • A default would be like, really bad. What happens when the “risk-free” asset is not actually risk-free, and vast swathes of people counting on being paid back wake up to find out that they won’t? $13+ trillion in assets worldwide becomes worthless (or at least valued a lot less in the case of some sort of haircut) while interest rates go way up. The economy crashes and maybe even the financial system collapses, worse than in 2008.
  • One benefit of an asset in such demand is that the U.S. government can borrow at cheaper rates than would otherwise be the case.
  • The Treasury can and has done buybacks of debt, but not in any large quantity since the budget surpluses of the late 1990s.
    • A buyback basically works by offering the lender money to get the bond back early, usually at the current market price. What Trump is saying is that if interest rates rise, as the Fed apparently plans, the market price of Treasury bonds will fall (because rates and prices of bonds move in opposite directions), creating the discount Trump is talking about.
    • The thing about buybacks is, while corporations can use them to their advantage, our government won’t be able to any time soon. The difference is that corporations usually have cash lying around they can use to buy back debt. Uncle Sam has no such luxury; its checking account, as of this writing, sits at $315 billion, while its total marketable debt is around $13 trillion. You could use this cash to buy back debt, but it’s more useful to have it in the account for paying expenses and for contingencies, like debt ceiling episodes.
    • So the other way would be to get money by issuing new bonds, but those new bonds would be at the higher interest rates–probably more than offsetting the gains from Trump’s discounts.
  • This is not to say we ought to spend ourselves into the ground using debt. Debt has to be sustainable, and there are some valid concerns about the sustainability of the national debt going forward. Japan’s national debt infamously stands at 200% of its GDP (U.S. is at 100), and thought its bonds haven’t suffered in the market, Wikipedia tells me nearly half of state tax revenues go to servicing the debt. Imagine most of your taxes just going to pay off debt. Student loans, anyone? (There, I managed to connect this post to Japan.) Hamilton said it well: a national debt, “if it is not excessive, will be to us a national blessing.”

So, I love debt. But do you, Donald?

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3 thoughts on ““A National Blessing”: Some Thoughts on Our Debt”

  1. Your perspective helped me to understand the value of debt. Nice job! It makes me feel that it is not a black and white issue where debt is just bad by being debt but more that we should responsibly go into debt to pursue innovation and growth while responsibly saving money to help reduce it and keep it at a level that is justified with the market.

    My concern, then, is not the fact of debt, but the inequality of who it serves. It serves the innovators, the wealthy, the investors, the big businesses. And by extension it serves all citizens of this country as well as much of the world, but it is unequal.

    The major demographic that our debt serves are those Anericans that have lived long enough to retire, while black teens in Chicago and impoverished around the world are dying before they’re thirty, not to mention the strain on world relations, especially on countries like China, that our debt puts us in (from what I understand), that could potentially threaten war in exchange.

    But all you have to do to see these unequal attitudes in action, so prevalent in Americans, is to head to Starbucks to find people who can’t give up their daily latte, while bearing a humongous college debt that they may never pay off, while children are begging for scraps of food around the world.

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    1. My argument here makes no judgment on the composition of the debt, just the size; that is, no presumptions on how the money is spent. One could argue that it is worth going into more debt to increase defense spending instead of welfare spending, or vice versa.

      Whom does the debt benefit? Well, you might have to look at what various groups of citizens pay in and receive. One such group might be retirees, like you mention, who currently are getting out more than pay in with social security. That said, they already paid taxes during their working lives. It’s just the size of this group (Baby Boomers) that is putting a lot of upward pressure on the debt. But in any case, you have to look at specific policies the government has in place (e.g. social security, defense, ag subsidies, foreign aid) to see whom benefits from this debt, which can’t be deduced from the size of the debt alone.

      Moreover, even retirees aren’t benefiting from the size of the debt currently. All else equal, more debt should increase interest rates, which should generate more interest income for a retiree that holds a Treasury bond, for example. But since the Fed has bought up a lot of this debt, interest rates have been near zero for some time, and retirees are getting very little interest income. So, the size of the debt alone does not tell us who is ‘winning’ here.

      The owners of the debt is one topic I didn’t touch on and maybe should have. On the one hand, yes, a country like China (or more recently like Saudi Arabia) could threaten to sell off its Treasury holdings. But that would likely hurt them more than it hurts us, as they generally accumulate these holdings for foreign exchange intervention purposes or for their own portfolios. That’s if they act rationally. If they don’t act rationally, and decide to sell, that will create some market turbulence, and there are several scenarios I could paint here. In all those scenarios, while bad, would not make the U.S. government seen as any less safe an investment. The private sector/other countries/the Fed could make up the demand easily, in my view. The key, of course, is to show everyone we’re serious about paying the debt as it comes due.

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