The national debt recently surpassed $35 trillion. Should we be worried? Contrary to common wisdom, the short answer is…not as much as you might think. $35 trillion is such a large number it can be hard for most of us to get our heads around. Debt IS a liability, but is only one side of a balance sheet. It is not well known, but the estimated value of US Government assets is about $200 trillion, several times the amount of the national debt. By way of comparison, the private sector holds about $185 trillion of assets against $40 trillion in liabilities, for a net worth of $145 trillion. National debt is commonly compared to gross domestic product (GDP), and a debt-to-GDP ratio over 100% has typically been predicted to cause problems. However, that ratio is not a fair measure and is a poor indicator of solvency. Individuals often have loans and mortgages that are well in excess of their annual income. It is not unusual for a wealthy nation to have high debt-to-GDP.
What is the national debt? It is the amount of money the federal government has borrowed since its founding, minus the amounts repaid over time. It can rise or fall but has mostly risen over time. The government borrowed $75 million to fund the American Revolutionary War. After the conclusion of the American Civil War in 1865, the national debt had grown to $3 billion. It then surpassed $22 billion following World War I and $258 billion after World War II in 1945. So why has debt grown so much and not bankrupted the nation? It is because debt issued by the U.S. government (Treasury securities) is not like the debt you and I borrow (mortgages, car loans, credit cards, etc.). It does not have to be paid back in the same way.
It would be a mistake to compare the financing of the federal government to that of a household or individual. The U.S. federal government is the issuer of its own currency, which also happens to be the world’s reserve currency – a currency that is required to transact business and for citizens to pay taxes. The primary way the government issues money/debt is by selling treasury securities on the open market. Investors around the globe buy these securities because it is a safe place to store money while earning a return – a much better option than storing cash in a bank vault or burying it in our backyard. Issuing too much money/debt than the economy can absorb can be inflationary. This is the major risk. Too many dollars chasing too few goods. Remember that the government’s debt is someone else’s loan. Who’s loaning them this money you ask? You are, along with other investors around the world that hold cash. It’s not under your mattress; it’s held in a bank or a brokerage account. These institutions, in turn, purchase treasury securities with your money. And the interest earned in a money market account is effectively interest being paid by the borrower. Yep, the U.S. government. What would investors do with their money if the government decided to pay back 100% of the debt tomorrow? We would need a place to store our money and would most likely want to reinvest it back into Treasury securities because it is a safe asset to own, and it pays interest!
Once you understand this concept, you realize the importance of federal debt and why the predictions of a pending implosion have never occurred.
As Alexander Hamilton put it in 1790 while drawing up the nation’s financial plan, “A national debt, if not excessive, will be a national blessing.” The reason the national debt is $35 trillion is because we are an extraordinarily wealthy nation with a vibrant economic system and a good credit risk to the world.
