Debt

Causes of Debt

If you are looking for causes of the national debt that isn't a list of political smearing, you've come to the right place. The only true cause of the national debt is the government spending more than it takes in. That is to say that government spending exceeds taxation, which creates a budget deficit.

To establish why the government consistently spends over its budget, we must understand the government's goals that would cause this behavior. While opinions may vary, a government is obligated to provide services that would be inadequately handled by the private sector. In America, these are things like education, public safety, national defense, regulators, economic stability, and a multitude of others.

Many sectors in the country can be aided by government assistance to better their citizens' lives. For example, the government invests in industries that support everyday citizens' lives.

When the government spends over its budget, it's doing so because it believes the good created from its spending will outweigh the harm caused by its growing debt.

Examine the graph in Figure 1⁸ below. The pink outlay line represents government spending. The teal line labeled revenues is how much money the government took in. The deficit is shown on the blue bar lines and the black line.

Fig. 1 - U.S. Budget 1962-2020. Source: Congressional Budget Office⁸

The first step to paying off any debt is to see how much to put towards paying it back and for how long. Except for the national debt, that isn't what's happening. Like all debts, there are payments to be made, so to fulfill these payments, the government will issue treasury stocks, bonds, and notes and use that money to make its payments. The government borrows money to pay back its debt, creating new debt.

The government is wary about paying back the debt with taxes because any increase in taxes reduces economic growth, which lowers the available base to be taxed. Now that isn't to say that issuing new debt doesn't create its own dilemma. Crowding out is the term given to loaners who have to compete with government rates, disrupting the natural efficiency of the loanable funds market.

So how does the national debt become a problem? Well, as all debts that aren't paid, they either declare bankruptcy or refinance. So why do America's lenders consistently allow us to refinance? Well, America has such a large role in the global supply and demand that bankruptcy for the United States could hurt our lenders more than refinancing our debt. A bit of the 'too big to fail' conundrum.

Types of Debt

The national debt for any country may seem massive, but not all debt types are created equal. Some debt, if held by citizens, does not hurt the economy. Whereas debt held by foreign countries can run some risks. The pie chart² below shows the percentage of debt each holder owns. Keep in mind that many U.S. government agencies buy treasury notes and bonds to secure funding for their efforts for years to come.

Fig. 2 - U.S. National Debt Holders. Source: Datalab²

The pie chart above in Figure 2 shows that 63.8% of the national debt is held by U.S. investors and the Federal Reserve. This is an important distinction because the money exchanged here stays within the economy. The investors spending the money or the government spending it both generate economic growth. Additionally, paying back the investors is putting more money into citizens' hands, which then circulates the economy. Critics of the national debt will refer to the share of debt China owns, implying that this gives leverage to China. While this is true to some degree, their share of the debt is fairly small in comparison. Additionally, it's very common for countries to own the debt of other countries.

Debt to GDP Ratio

A common way of analyzing national debt is to compare it to GDP. This is done because GDP is seen as a productive measure of an economy, implying how well an economy would be at paying off debt.

\(\hbox{Debt to GDP Ratio}=\frac{\hbox{Total Debt of Country}}{\hbox{Total GDP of Country}}\)

This comparison is used by investors to determine the quality of loanable funds.

The same logic in the example above is applied by investors, the lower the debt to GDP ratio, the more confident they are it is a safe investment.

So what is the United States Debt to GDP ratio? According to FRED, in the first quarter of 2021, the debt to GDP ratio was 124%.⁴ That means the national debt is larger than the productive output of the entire economy by 24%. So what does that change exactly? In theory, investors will lose faith in a debtor's ability to pay back at some point. However, when it comes to the largest economy in the world, it is unlikely to lose the faith of its investors soon. The United States debt to GDP ratio isn't an outlier, and what the ratio means for a country has many other variables involved.

Debt Example

Let's consider a few countries by looking at their Debt to GDP ratio, GDP per capita, and Human Development Index (HDI). These measures will be used as a loose estimation of the quality of life for their citizens. Using HDI, we'll compare correlations in debt to quality of life outcomes. We'll compare Japan, Cambodia, and Venezuela.

Table 1 - Debt to GDP and Quality of Life Comparison. Sources: Worldpopulationreview^5,7 , The World Bank⁶

In Table 1 above, the three countries are compared on three different metrics: the size of economy per citizen (GDP per capita), debt relative to the economy size (debt to GDP), and quality of life measure (HDI).

We can see that the three countries have very different outcomes with no clear correlations. Japan and Venezuela have extremely high Debt GDP ratios. Yet Japan's GDP per capita and HDI are very high, even compared to the rest of the world.Venezuela is a common political scapegoat for its debt and scarcity issues. However, its GDP per capita isn't as good as Japan's, but it still much better than Cambodia's.

Despite having very little debt, Cambodia has a very low GDP per capita, implying that small amounts of debt may not be ideal.The main takeaway is that national debt is one of many factors for a country. Some may leverage it to their advantage and flourish. While others who are debt averse may be missing opportunities to grow their economy.