By Sun-Yong Kim
In an age of unprecedented public leveraging, no single phenomenon has captured the universal concern of the modern economic world as has the ballooning size of the US public debt. Standing at $16.7 trillion USD, the public debt of the United States ranks at 102% of GDP with the CBO projecting it to reach 199% of GDP by 2040, a level that would make America rival Japan as the most indebted nation on the planet. Whilst such figures are staggering, they only serve to distort the real truth about US public debt, which is considerably rosier than the morbid picture often painted by US critics.
The truth of the matter is that commonly quoted debt measures such as the Debt to GDP ratio are poor indicators of a nations likelihood of default. Merely dividing a nations total debt by its GDP tells us nothing about a countrys ability to service its debt because it fails to take into account sovereign differences between nations that may help explain differences in Debt to GDP ratios. For example, developed economies such as the United States tend to possess more financial assets relative to their GDP than developing economies because the wealth differences between the developed and developing worlds mean that rich country investors are far more likely to hold domestic debt securities than their developing counterparts. This does not imply that developed economies are less able to service their debt than developing ones, rather, the diverging debt to GDP ratios between developing and developed nations is merely indicative of the macroeconomic imbalance that currently exists in the global economy.
The fact that higher debt to GDP ratios in the developed world do not correlate to deteriorating debt serving capability can be seen by the historical movement in the yields. Japan has long possessed the largest debt burden in the world with a total debt that represents 233% of GDP, yet their yields represent one of the lowest interest rates in the world. In the United States, despite the fact that the public debt has expanded by $3 trillion USD in the past 3 years, the amount the U.S. government pays to service its debt relative to the size of the economy has dropped to levels well below the boom years of the 1980s and 1990s due to record low interest rates. In fact, the net interest payment as a percentage of GDP, a far more reliable measure of debt sustainability, is poultry 1.6% of GDP, a level not seen since the 1970s.
In addition to these facts, it is common knowledge that in a fiat currency system, nations that print their own currency can never default because even in the worst case scenario they can print an infinite supply of local currency to meet debt obligations. Whilst critics have often argued that such a policy would lead to hyper-inflation, the United States has a unique advantage as the location for the worlds reserve currency. Even if dramatic amounts of USD were printed, the demand for the worlds reserve currency is such that any additional supply of the currency would be immediately offset, leading to relative price stability. This perhaps explains why at a time when the Federal Reserve has undergone unprecedented quantitative easing, inflation in the United States has remained relatively stable at 1-2%.
Whilst it is apparent that even at the current astronomical levels of US debt there is no realistic expectation that the US will default, recent indicators would suggest that the US debt has reached its peak and is beginning a gradual trajectory back towards normal levels. According to the CBO, 2011-2013 represented the biggest decline in the US federal deficit since the 1970s as the economy began to recover and the sequestration cuts were enacted with a Budget Deficit of 10% of GDP in 2009 shrinking to 4% of GDP by 2013. Under the CBOs baseline projection, the deficit would continue to drop over the next few years, falling to 2 percent of GDP by 2015 with the consequence being that by 2018, federal debt held by the public would decline to 68 percent of GDP, a debt level lower than that of Germany, a nation often lauded for its fiscal responsibility. As esteemed economist Paul Krugman has previously noted: It’s not even a picture of a crisis.”
This rather optimistic view of US debt sustainability seems to contradict the basic common perception that the US public debt is unsustainable. Yet, a closer look at the facts and figures confirms that it is the true reality corresponding to the US debt situation. The current economic debate should begin to reflect this new reality so as to avoid misleading US public policy makers into adopting misguided macroeconomic policies on the mistaken belief that a debt crisis is looming.
The author is a Commerce/Economics student at the University of New South Wales where he majors in Finance, Economics and Econometrics. He is a member of the Australian Liberal Party and has a keen interest in many political and economic issues ranging from macroeconomic policy to environmental sustainability. He has been active as an editor and writer with his recently launched a policy magazine/blog, Aus Solutions which is available at. www.aussolutions.com.au