By the time you read these words, Congress will be putting the finishing touches on President Biden’s COVID-19 relief package, with American taxpayers footing the bill to the tune of $1.9 trillion.
Of course, Congress has no intention of actually increasing taxes to fund its profligate spending. Instead, the Treasury will simply issue an additional $1.9 trillion of debt securities – Treasury bills, notes, and bonds – to “pay” for the expense.
And if no one wants to buy them? That‘s not a problem, because the Federal Reserve will simply slurp them up as a failsafe and add the debt to its bloated balance sheet, already closing in on $7.5 trillion.
When added to the current total of $27.9 trillion, Biden’s package will raise the national debt to $29.8 trillion. Including the $1.9 trillion relief package, that’s an increase of more than $7 trillion over just the last 18 months. Meanwhile, the federal government’s debt to GDP ratio will increase to nearly 140%.
That’s the highest it’s ever been in America’s 245-year history. It’s higher even than in World War II, when federal spending soared as the country borrowed heavily to finance the war.
Of course, it’s possible that the senate will reject the added spending. Biden will need all 50 Democratic votes in the senate to get his plan through Congress, plus the vote of Vice-President Kamala Harris. All 50 Republican senators are expected to oppose it. But at least one senate Democrat – Joe Manchin of West Virginia – has expressed skepticism over some of its aspects.
If the senate won’t go along with the Biden plan, there’s an alternative proposal backed by Republicans that will cost “only” $618 billion. If that one passes, it will raise the national debt to a mere $28.5 trillion and the debt-to-GDP ratio to just 133.6%.
And then, there’s the “small” matter of Uncle Sam’s nearly $240 trillion in unfunded liabilities – promises made to federal pensioners, Social Security recipients, Medicare beneficiaries, and more with no current funds allocated to pay them. That’s eight times the national debt.
Whichever bill passes, it seems to us that the next legitimate question to ask is, “at what point is the national debt too high?”
We’ve been asking ourselves that question for a long time. Indeed, we’ve heard scary things about the national debt all our lives, but things always seem to work out. Honestly, we feel a little like the shepherd boy who cried wolf.
Still, the World Bank believes that a debt-to-GDP ratio above 77% suppresses economic growth. And the higher the debt, the larger its growth-slowing effect.
But maybe the World Bank and other debt vigilantes don’t know what they’re talking about. After all, seven countries have debt-to-GDP ratios higher than ours, with Japan leading the way with an astronomical 266.1% ratio at the end of 2020.
It’s also possible we’re thinking about debt the wrong way. Perhaps instead of focusing on our ability to pay down or even eliminate the national debt, we should be thinking of its real-world effects on our economy.
For instance, in fiscal year 2020, Uncle Sam spent (or more accurately, borrowed) $345 billion to make interest payments on the national debt. That amounts to about 5.3% of total federal spending. Because of the lowest interest rates in 5,000 years of human history, interest payments on the debt have grown much more slowly than the debt itself.
The 5.3% figure is reassuring to mainstream economists because it indicates that the financial burden of paying interest on the debt isn’t causing significant stress on the economy. They believe the debt will only become problematic if the Fed raises interest rates to fight inflation. But last August, the Fed announced a new strategy allowing it to accept higher inflation rates without increasing rates.
Another possible consequence of higher inflation is a sinking dollar, especially if interest rates don’t increase to help offset it. Indeed, while the Consumer Price Index rose only 1.4% in 2020, the US Dollar Index, a trade-weighted measurement of the dollar’s value against a basket of major currencies, fell more than 7%. (Although we also believe the CPI vastly understates the real inflation as measured by a fixed basket of goods and services.)
It’s also sobering to consider the changing opinions of people like Janet Yellen, who the Senate confirmed as Treasury Secretary last week. In January, Yellen said Congress needed to “act big” with its COVID relief package. Yet scarcely three years ago, she said a national debt of only $20 trillion “should keep people awake at night.”
Perhaps we should be reassured that Yellen, surely one of the smartest economists in the world, thinks we should spend money now and worry about the debt later. But we still remember how the fairy tale of the boy who cried wolf ended. When the wolf finally came, the villagers didn’t believe the boy’s warning. The wolf killed their sheep, then slipped away into the forest.
Will our escalating debt have a similar outcome? Only time can tell. In the meantime, since no one can reliably forecast the future, it only makes sense to plan for uncertainty.
