borrowings, debt, devaluation, economic growth, economics, exports, fiscal deficit, fiscal policy, GDP, gross domestic product, inflation, investment, national debt, taxation, trade deficit, Treasury bonds, US dollar, US economy
(originally published in 2011 to Helium writing site, now gone; much of the commentary in the article is still relevant)
National debt in the US comprises debt held by the public as well as intragovernmental debt and is currently valued at more than $14 trillion or roughly the same amount as the country’s annual gross domestic product. The US economy is recovering from its biggest downturn since the 1930s depression. The recovery is tentative, with annualized growth in gross domestic product slipping from 3.1% in the December quarter to 1.9% in the March quarter, and national debt continues to climb.
Perhaps the simplest way to see the effect of the national debt on the US economy is to envisage a household with a mortgage. Some proportion of their income has to be paid in interest to the bank. This means the family has less money to spend on other things. The situation is the same for a nation. If it has a substantial debt, there will be less funding for health, education, social welfare, important infrastructure programs, and so on.
The high national debt is one of the things pushing the value of the US dollar down against other leading currencies, such as the euro and the yuan. This puts upward pressure on inflation and increases the possibility of a devaluation, which would in turn put the dollar’s status as a major reserve currency at risk. This means the US would have to pay higher interest rates on its borrowings, pushing the debt up even further. The national debt is expected to rise to $23 trillion by 2019 and the annual cost of servicing the debt is projected to increase more than threefold to over $700 billion.
The US will have to rely on increases in the sale of Treasury bonds and possible rises in taxation to fund the debt. Treasury bonds are a popular investment and the US should have no trouble attracting funds into them, but their sheer volume and servicing costs will take funds from elsewhere. Higher taxes will be unpopular and may further dampen economic activity in the short term. In recent years, the US has had an expansionary fiscal policy to try and boost the economy. However, the Government Accountability Office has said that the current fiscal trend is unsustainable and the deficits will somehow have to be reined in. Any tax increase or spending reduction will be difficult but may eventually be necessary if the US is to reduce debt and return to higher long term growth.
Not only does the US have a large fiscal deficit but it also has a significant trade deficit with imports far exceeding exports. The trade deficit has been running at more than $40 billion a month. This has to be funded by borrowing. The risk is that foreigners might sell off large holdings of US dollars due to its falling value and general economic conditions in the US. This would make it harder for the country to raise funds to service its debt. It could also spark an international economic crisis, with repercussions for all economies including the US.
The higher the national debt, the more savings are channeled into government borrowings, with Treasury bonds having to be made more attractive (including higher interest rates) in order to obtain the extra funds needed. This will shift savings away from more productive forms of investment in factories, shops, and other businesses. Output and incomes would therefore be lower than otherwise. Savings, and consumption, would fall if taxes were increased to help pay the extra interest costs associated with larger national debt.
Not surprisingly, high debt has an adverse effect on growth in gross domestic product. The National Bureau of Economic Research found that over a 200 year period, annual growth in 20 advanced economies averaged 3-4% if debt was less than 60% of GDP, but only 1.6% if debt was more than 90% of GDP. The current US figure is close to 100%. The study found that the relationship between debt and growth in the US was similar to the average for all countries. The study also found that inflation in the US was considerably higher when debt levels were high.
It is quite clear that the large national debt will have an adverse effect on the US economy. It will decrease the value of the US dollar, push up inflation and raise interest rates. High debt will place pressure on the fiscal and trade deficits, at a time when both are already quite large. It will reduce savings and also divert funds away from more productive investments. Economic growth rates will probably remain low for however long national debt stays high.