Recent data of the US Treasury Department revealed that the US’s national debt has expanded by $1.2 trillion. At the end of the financial year 2018, data shows that the debt was estimated at $21.52 trillion. A national debt occurs when a country spends more than the Treasury collects. Historically, during periods of…
Recent data of the US Treasury Department revealed that the US’s national debt has expanded by $1.2 trillion. At the end of the financial year 2018, data shows that the debt was estimated at $21.52 trillion.
Background
A national debt occurs when a country spends more than the Treasury collects. Historically, during periods of war and recessions, the US debt as a share of the Gross Domestic Product had been high. For instance, during World War II, the debt held by the public as a share of GDP peaked at 113 per cent of GDP in 1945. However, debt declined over the following 35 years. In addition, ageing demographics and rising healthcare also have accumulated to the concern of long-term sustainability of the government’s fiscal policies to manage the public debt.
During the 1980s, excessive defence spending and sweeping tax cuts led to a new period of rising debt. However, in the ‘90s, the increase in taxes and defence cuts led to an economic boom that significantly reduced the debt as a percentage of GDP. Consequently, from 1998, US experienced four consecutive years of budget surpluses.
Yet, during George W.Bush’s Presidency, deficits returned. As the period saw an expansion in war spending in the Afghanistan and Iraq, in addition to Medicare. Under President Barak Obama, the country experienced the Great Recession, hence the government continued the Bush administration’s bank bailout program that brought billions in the fiscal stimulus due to the rising annual deficits.
As of July 31, 2018, debt held by the public was $15.6 trillion and the intragovernmental holdings equalled to $5.7 trillion, for a total of $21 trillion. Public debt estimated to approximately 77% of GDP in 2017, thus, ranking 43rd highest out of 207 countries. The Congressional Budget Office forecast in April 2018 that the ratio will rise to nearly 100% by 2028, perhaps higher if current policies are extended beyond their scheduled expiration date.
Analysis
According to the Treasury Department’s Bureau of the Fiscal Service, the national debt at the end of the fiscal year 2017 was estimated at $20.25 trillion. However, recent data show that America’s data has inflated by $1.2 trillion to a staggering $21.52 trillion on the last day of the fiscal year 2018.
Public Debt as a percentage to the country’s GDP has also increased from 6.3 per cent to 105.4 per cent. The Treasury Department’s Bureau of the Fiscal Service also stated that the occurrence of the large deficit was a result of federal benefit payments being pushed earlier in August instead of September.
Jason Furman, American economist and professor at Harvard University’s Kennedy School of Government and a Senior Fellow at the Peterson Institute for International Economics expressed that “We’re the only advanced economy where the debt is expected to rise as a share of GDP over the next five years. All the other advanced economies, it’s falling.”
The biggest concern is the increase in spending on Social Security payments, pressure from the rise in a number of baby boomers rising and a rise in payments for Medicare.
Chris Edwards, director of tax policy studies at the Cato Institute said that “A rising debt could create this crisis situation where interest rates spike, the government has to take drastic actions, perhaps cutting benefits, social security and other benefits radically, or hiking taxes dramatically, which will damage the economy.”
When interest rates rise, it would make borrowing more expensive without even an additional debt. However, tax cuts passed in the previous year have further increased the deficit. Also, the budget bill which was approved in February will add to the financial pressure.
Counterpoint
China is the biggest holder of U.S. debt — $1.17 trillion as of January which had been built up over decades. The fear is that as the United States and China inch closer to a full-fledged trade war, economists and investors worry about worst-case scenarios that could impact the global economy — and America.
Thus, if this trade war does escalate, then more tariffs could be slapped on more goods. But China could fire back by selling a large portion of the $1.17 trillion of U.S. Treasury bonds it holds. Jeff Mills, co-chief investment strategist at PNC Financial Services Group said that if China floods the market with treasuries, and the supply of U.S. bonds spikes, then fixed income prices would fall and yields would rise. If yields climb then it would become more expensive for U.S. companies and consumers to borrow and that would cause the U.S. economy to slow down.
Many deficit hawks believe that the rising deficits would expose the United States to a kind of an economic crisis similar to Greece or Argentina. However, many experts say that this is likely impossible because the US dollar is the world’s reserve currency.
Assessment
Our assessment is that a strong fiscal outlook is essential for any economy and now is the time for investors and policymakers to pay attention to the problem of growing debt. We believe that rising public debt would lead to a ‘crowding out effect’ i.e. when increased interest rates could lead to a reduction in private investment spending. We feel that every dollar of taxation spent will be appropriated by transfer payments and interest on the debt.
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