The National Debt

Little is said these days about the national debt except when one party wants to point the finger at the other for increasing it. And the reason so little is said is because both parties share responsibility for its continued increase. Former President Barack Obama (D) nearly doubled the size of the national debt during his eight years from $10.025 Trillion at the end of 2008 to $19.573 Trillion at the end of 2016. President Donald Trump has added slightly less than $2 Trillion to bring it to $21.516 Trillion through 2018. The sheer size of the debt has become so perceptively large that Republicans and Democrats in a rare form of bi-partisanship (mutual embarrassment) temporarily suspended the ceiling on the national debt. But is the national debt too large?

The size of the national debt can be viewed from two different perspectives. First, it can be viewed from the personal level much like a mortgage. As one’s income and personal wealth increases, there is a tendency to buy more expensive housing and thus increase one’s mortgage (debt). In such instances it is not the actual amount of the mortgage (debt) that is incurred but rather the ratio between earnings and debt or earnings and servicing of debt (monthly mortgage payments). Housing can be considered a recurring expense that you will always have, whether it is by rent or by mortgage – unless you are fortunate enough to pay off your mortgage wherein it becomes a reduction in recurring expense in retirement. In other words the size of debt it a function of income.

Second, it can be viewed from a business perspective. Debt (as measured by interest rates) is almost always cheaper than equity (as measured by investor expectation for a return on equity). If it isn’t you need to either change your financial institution or take a hard look at the fact that your are headed for bankruptcy. (Unless, of course, you have managed to tap into the government gravy train like the green industries have.) Most often debt is incurred to facilitate capital expenditures. Incurring debt for payment of recurring costs – unless you are in a “start-up phase” generally means you are headed for bankruptcy. Many large businesses have a “permanent” level of debt that they routinely refinance. The size of that debt is most often a function of earnings and growth. And it is most often reflected in the ratings of a company’s debt (Moody’s, Standard and Poor’s, and Fitch’s) which in turn determines the cost (interest rate) for acquiring or refinancing that debt.

The “reasonableness” of debt then is basically measured by revenue and growth in that revenue – the reasonable ability to repay. That should be equally true of the national debt. The actual size of the debt should be juxtaposed against a common factor relating to the ability to pay – in this case the Gross Domestic Product (GDP) reflecting the total value of goods and services generated each year.

So what is a reasonable percentage to apply when looking at the national debt vs. the GDP. From end of World War II to the end of President Ronald Reagan’s administration that accumulated national debt averaged less than fifty percent of the GDP. During President George H.W. Bush time in office the debt rose to about fifty-six percent of GDP. Under President Bill Clinton the ratio crept up to an average of about sixty-two percent. President George W. Bush, despite the beginning of the War on Terror and the commencement of wars in Afghanistan and Iraq and the commencement of the Bush/Obama recession, managed to hold the ratio of debt to GDP at about sixty percent. But the advent of Mr. Obama’s presidency steadily increased that ratio from eighty-three percent to a high of one hundred four percent in his final year – averaging slightly over ninety-six percent. Mr. Trump has continued the prolific spending and is averaging about one hundred four percent of GDP.

So what is the correct ratio? According to Investopedia a study by the World Bank indicated that a sustained ratio above seventy-seven percent will slow economic growth. I doubt that is correct because it does not factor in the current economic growth rate. During Mr. Obama’s term, America’s economy grew, on average, at less than two percent – a pitiful figure given the overwhelming underlying strength of the American economy unburdened by repressive regulation and burdensome taxes. Thus far, according to economic growth under Mr. Trump has averaged just under three percent – a fifty- percent improvement.

Determining an absolute level for the ratio between debt and GDP is irrelevant because that level will change from time to time based on the relative performance of our economy. Suffice it to say that the current level is excessive and Mr. Trump and Congress should act promptly to lower spending while encouraging further economic growth.

The dangers that lurk are easily seen and experienced as recently as the Bush/Obama recession (2008-09). The ratio between the national debt and GDP at that time was sixty-eight percent and the resulting recession was the second worst in our country’s history. A recession is defined as two-consecutive quarters of negative growth in the GDP. The “fed funds rate” sat at 5.5% and began a steep decline in the latter part of 2008 to 0.0% in order to bolster an economy that was beginning to fail. While it may have mitigated the economic decline it did not stop the recession.

According to Chart Book: The Legacy of the Great Recession 8.7 Million jobs were lost, the stock market declined by over fifty percent, and housing values dropped by nearly thirty-two percent. A 2014 article by Colin Smith in the noted that Americans lost nearly $14 Trillion ($8 Trillion in the stock market and $6 Trillion in housing value). (That amount would have wiped out the national debit prior to the disaster of the Obama presidency.) The current ratio of national debt to GDP is over fifty percent higher than in 2008 and the “fed funds rate” is nearly fifty percent lower. A recession is coming as sure as night follows day – recession always follows a period of economic expansion and the current economic expansion is the longest we have had since the Civil War.

Unless Mr. Trump and Congress begin to address the national debt and the prolific spending adding annually to it, the next recession will make the Bush/Obama recession look like a cakewalk.