How much debt is too much for the United States?

Of all the topics I get asked about, concern over the United States growing public debt and the fate of the U.S dollar come up the most. It makes sense to everyone that the debt can’t keep growing as quickly as it has in recent years. Everyone seems to fear that there will be real consequences if it does. They’re just not sure what the consequences will be. We’ve been in the midst of the most highly contested Presidential election any of us can remember, and neither candidate has addressed this issue. In fact, on October 11th, 2024 Barrons published a guest commentary by David K. Young entitled, “The biggest problem Trump and Harris aren’t talking about”. According to the article the U.S. national debt is currently $36 trillion.  "Annual interest payments on it are set to exceed $890 billion. To put that in perspective, we’re spending more on servicing the debt than on the entire U.S. defense spend ($866 billion)."

Total U.S. debt is now approximately 127% of gross domestic product (GDP). In the year 2000 it was only 55.6% of GDP. The table below, from VisualCapitalist.com, shows the growth of debt for 20 developed countries since the year 2000. Look closely at the table and you can see that only Japan, Singapore and Greece have debt that is a higher percentage of GDP than ours. (Hint: higher is not better!)

(Source: Visual Capitalist.com April 18, 2024)

The United States has always had deficit spending, even during the Revolutionary War. It was in 2008, during the heart of the financial crisis, that the rate of growth really accelerated. Since then Democrats and Republicans have relied heavily on deficit spending to keep our economy growing. According to a study by the World Bank, countries with a debt-to-GDP ratio above 77% for a prolonged period experience significant slowdowns in economic growth. The U.S. debt-to-GDP ratio has been above 77% since 2009, following the financial crisis that started in 2007. (Source: Congressional Budget Office. “Federal Debt: A Primer”) Need confirmation? Japan’s gross domestic product, with a debt load of 252% of GDP remains below its mid-1990’s peak!! 

Whittier Trust Company recently published their 4th Quarter 2024 Market Insights featuring an article titled “How Heavy is the U.S. Debt Burden?” Whittier concluded that, “we do not expect the national debt burden to create meaningful higher inflation, higher interest rates, or a weaker dollar in the foreseeable future of 3 to 5 years." They argue that the following should offset concerns about rising debt levels:

1. We issue debt in our own currency, which happens to be the world’s reserve currency. 
2. Our central bank is highly regarded and enjoys strong global credibility. 
3. The U.S. has solid governance mechanisms to guard against excessive fiscal dominance: two political parties, and two independent chambers of Congress provide institutional checks and balances.

Whittier also says, “One of the biggest concerns surrounding the elections is the potentially negative impact of both candidates’ campaign promises on an already high level of U.S. national debt. Neither candidate has come across as fiscally responsible; their fiscal profligacy is instead projected to increase government spending by an additional $5-7 trillion over the next 10 years.” 

While the Whittier study is long and detailed, their concluding summary is short and concise:

"We recognize how intensely people feel about the national debt burden. We also understand that there are several intuitive reasons to worry about it. We pass no judgment to either condone or condemn it in this article; we simply examine its likely economic and market impact in the coming years. We summarize the many reasons why investors hold U.S. government debt and will likely continue to do so on similar terms.

• High credibility of monetary policies
• Unparalleled size, safety, quality and depth of the U.S. bond market
• U.S. dollar as the world’s reserve currency
• Lack of viable alternatives for domestic and foreign investors
• Diversification and hedging needs of long duration asset owners
• Solid governance against fiscal dominance
• Global glut of savings
• Disinflation from technology
• Vibrant economy and formidable military 

We do not expect the national debt burden to create meaningfully higher inflation, higher interest rates or a weaker dollar in the foreseeable future of 3 to 5 years. We remain vigilant and alert, but we maintain our conviction that the U.S. economy continues to head steadily towards a new equilibrium. We do not anticipate any imminent major shocks in this new economic cycle and bull market."

I’m cheering for Whittier to be right! Their conclusions merit respect and seem credible, but I worry that they are based on assumptions that may be too optimistic or ignore other factors that could be important to consider. Let’s take a look at some of those other factors using information from  a report by the Peter G. Peterson Foundation, dated August 21, 2024. 

1. The Congressional Budget Office (CBO) projects Trillion dollar deficits for the next 10 years through 2024. That is $10 trillion total, not the $5 to $7 trillion that Whittier is projecting. 
2. The CBO is currently projecting that short term interest rates will fall to 2.8% over the next couple of years. If interest rates turn out to be higher carrying costs of the debt may be greater than anticipated. 
3. Higher interest costs could crowd out important public investments that can fuel economic growth in priority areas like education, research and development and infrastructure. 
4. On its current path the United States is at greater risk of a fiscal crisis, and high amounts of debt could leave policymakers with much less flexibility to deal with unexpected events. If the country faces another major recession like that of 2007–2009, it will be more difficult to recover.
5. The unsustainable fiscal path could threaten the safety net for the most vulnerable in American society. If the government does not have sufficient resources, essential programs like Medicaid and Social Security could be put in jeopardy.

 To quote Whittier, the single biggest reason that the U.S. can have so much debt is that “We issue debt in our own currency, which happens to be the world’s reserve currency.” The U.S. dollar’s ascent to reserve currency status began during World War I when the United States became a crucial exporter for war materials and food, trade that was settled in US dollars. In the post-war period, the US provided substantial support—in dollars—for reconstruction. Events near the end of the Second World War made the US dollar the supreme currency in the world. In July 1944 delegates from 44 countries met in Bretton Woods to create an efficient foreign exchange system, which in turn established the U.S. dollar as the reserve currency. It also established the International Money Fund and the World Bank. The Bretton Woods system would eventually collapse when President Nixon uncoupled the U.S. dollar from the price of gold. But the tradition of using the dollar as the world’s reserve currency has survived for reasons Whittier points out, including:

1. Unparalleled size, safety, quality and depth of the U.S. bond market
2. Lack of viable alternatives for domestic and foreign investors

But reason #2 is much less true today than any time since 1944. The Euro was launched in 1999. Today it is used for over 20% of all international transactions. The Japanese yen typically has a 4 to 5% share. The dollars share has shrunk from nearly 100% in 1944 to approximately 60% today. That took 80 years, but the next 10-20% of shrinkage could happen much faster. When less than half of all international transactions take place in dollars it would be hard to claim reserve currency status! 

The BRICS group of countries has emerged since 2000. This is an acronym for Brazil, Russia, India, China, and South Africa. BRICS is not a formal “trade agreement” but they seek economic cooperation among member nations to increase their economic and political standing in the world. On January 1, 2024 they admitted four new members to the group: Egypt, Ethiopia, Iran, and the United Arab Emirates. They are now referred to as BRICS+ and represent approximately 35% of world GDP, adjusted for purchasing power parity (PPP). That compares to 14.5% for the European Union and 15.5% for the U.S. (early 2024)

BRICS established The New Development Bank (NDB) in 2015 to provide emerging markets and developing countries with funding for infrastructure and sustainable development projects. BRICS+ is working on developing alternative payment systems and potentially a common currency. Many of the BRICS+ countries have already established bilateral trade using only their own currencies. China and Japan (a key U.S. ally) now trade directly in Chinese Yuan and Japanese Yen, eliminating the need to purchase U.S. Dollars. BRICS+ has overtaken the G7 (U.S., Canada, UK, Germany, France, Italy, Japan and Germany) based on their share of world GDP in purchasing power parity terms. You can see from the chart below that G7 share has been shrinking for over 20 years, while BRICS+ is growing.

"As more countries join the BRICS+, it will give the group even more economic clout. 

Meanwhile, the US economy’s global GDP share is falling, and its debt is hitting new heights as it issues more Treasury bills, notes and bonds to fund current government spending…. Inflationary shocks followed by interest rate increases have made servicing this debt very expensive for U.S. taxpayers….” (Source: The Conversation, January 12, 2024)

Another example of waning U.S. influence and economic dominance presented itself when Russia invaded Ukraine in February 2022. That prompted the U.S. to impose unprecedented economic sanctions against Russia. The aim was to damage Russia’s economy and reduce its ability to wage war. The sanctions have not worked. Russia simply found other bilateral trading partners, mostly for its oil and gas. India replaced Europe as the key customer for Russian oil. Russia’s trade with China has grown significantly and 90% of trade between the two countries is conducted in rubles and yuan. 

If you haven’t already figured out the trends, I’ll state them plainly. It is now 80 years since Bretton Woods. It’s 79 years since the end of World War 2. The United States was the only superpower left standing after that war. It was natural that the U.S. Dollar became the reserve currency. It is natural that we financed the reconstruction of Europe, Japan, and much of the rest of the world. The rest of the world rebuilt. The global economy is now larger and more diverse than ever before. Technology has rapidly accelerated its growth. We are now 24 years into a new century in which the U.S. shares economic power with China, Japan, India, Europe, BRICS+, and the rest of the G7. The economic playing field continues to level. Prior to 2000, the U.S. topped the world trade rankings. Back then, over 80% of countries traded more with the U.S. than with China. Since then, the U.S. dominance in trade has declined as China has taken the top spot in 128 countries. The world is moving on from the era of American dominance and empire, and that shouldn’t surprise anyone. This is a cycle we have seen many times throughout history going all the way back to the empires of the Greeks and Romans. Great Britain dominated trade and spread their empire for almost 200 years before it all began to unravel following World War I. The ending of empires has never happened “overnight”. It takes time. I can’t tell you when the U.S. Dollar will lose its status as the world’s reserve currency, but I can tell you that it will happen someday. Whether that is 10, 20, or 30 years from now is unknown. It took decades for the British Pound to fall from reserve currency to a second class currency. 

What will happen if the dollar loses its status at the reserve currency of the world? 

1. We will have less access to capital. We can’t just issue debt if there are no buyers for the debt.
2. Borrowing costs will probably increase as it will take higher rates to incentivize buyers to purchase the debt. 
3. If foreigners no longer want to hold dollars for reserves, it will force significant “belt-tightening” in the U.S. 
4. “Belt-tightening” will most likely mean a smaller military force. Great Britain’s once mighty navy ruled the world, until it could no longer afford it. 
5. “Belt-tightening” will also mean that the government will have a lot less capacity to bail the economy out of the next serious recession.

Please bear in mind that the demise of the U.S. dollar is not imminent. To be clear Whittier is making the case that nothing terrible is likely to happen within the next 3 to 5 years. For the record, JP Morgan recently released a similar report, with similar conclusions. Charles Schwab wrote a report on the topic in April of 2023. This is their opening paragraph. 

“There has been a long-term trend toward currency diversification in global financial transactions and trade, but we don't see the U.S. dollar losing its dominance any time soon.”

However the long-term trend away from the dollar is real. In my opinion it is not likely to reserve itself. That is especially true if it is used indiscriminately to shore up the U.S. economy and as a weapon against others. In my opinion, the U.S. has become too dependent on larger deficits than we can afford. It is clear to me that expanding the debt beyond our ability to effectively service it will only hasten the trend away from the dollar as the reserve currency of the world. 

If you want to learn more, including possible solutions you are welcome to spend some time on the website of the Peter G. Peterson Foundation, https://www.pgpf.org/.

All the best,
Paul

Paul Krsek
CEO
5T Wealth, LLC
Main (707) 224-1340
595 Coombs St
Napa, CA 94559

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