Will Government Debt Crush the U.S.?

The U.S. government has been naughty. Very, very naughty. In recent years, it has rung up trillions of dollars in debt as it has consistently spent more than it has taken in from taxes and other revenue.

Figures, right? Just as profligate American consumers are getting their comeuppance and learning that hoisting themselves up on an impossibly high mountain of leverage wasn't such a good idea, the government is busy doing the exact same thing.

If you listen to many pundits out there, this rapidly ballooning government debt load is getting ready to cause our entire economy to implode. And it often sounds like there's a pretty compelling argument there. To start paying down that debt, Uncle Sam is going to have to make big spending cuts, raise taxes, or do a bit of both.

Cutting back spending could put a hurting on big government contractors in defense -- such as Boeing (NYSE: BA  ) and General Dynamics (NYSE: GD  ) -- as well as more general contractors like Jacobs Engineering (NYSE: JEC  ) and Accenture (NYSE: ACN  ) . Spending cuts could also put government employees out of work and cut off money to citizens on the dole.

Increasing taxes, meanwhile, has the inevitable consequence of leaving consumers with less money to pump back into the economy. By reducing individuals' income, the government runs the risk of adding more fuel to the housing fire, which would only exacerbate the problems at banks like Citigroup (NYSE: C  ) and homebuilders like Beazer Homes (NYSE: BZH  ) . Reduced disposable income also means that consumers would have less to spend on a wide range of items -- but especially luxury goods like those at Coach (NYSE: COH  ) .

The future's so bleak
I've seen more than a few pundits, commentators, analysts, and random Joes become frothy at the mouth talking about the economic apocalypse that will be ushered in thanks to the government's debt load. Time will tell whether the roof will cave in on the U.S. economy, but I expect that these folks will end up being far off the mark.

While the government's debt level and budget deficit aren't sustainable, fire and brimstone still isn't a very likely outcome. Of course, it's much easier to get heard on CNBC and other major news outlets if you have an extreme, highly improbable view -- and easier still if you express it while shouting, sweating, wildly gesticulating, or all three at once. If sober, sane views were encouraged, Jim Cramer would have been off the air a long time ago.

But enough of that
Making broad, unsubstantiated claims really isn't all that useful, though. So let's cut the jibber-jabber and take a look at how some of the major debt concerns stand up to the data.

1. The government is weighed down by its huge debt load. For right now at least, this is actually very far from the truth. On average, from 1989 to 2009, the government paid total annual interest equal to roughly 3.8% of total U.S. gross domestic product. In 2009, interest came to 2.7% of GDP. Government debt has ballooned, but currently people are willing to lend to Uncle Sam at very low rates.

2. When interest rates rise, the government is in big trouble. As I highlighted in the point above, low interest rates are helping the government deal with its massive debt load now, so rising rates certainly wouldn't help matters. However, there are a couple of things to consider here.

First off, the government's interest payments may continue to come down even if rates stay put or go up slightly. In the coming months (and years), the Treasury will roll over debt taken out years ago when rates were still higher. In mid-August, for instance, $22 billion of 10-year notes that were paying 5.75% will come due. Currently, 10-year notes are yielding just 3.07%.

Also, most of the marketable government debt is in Treasury notes. As of June 30, the weighted average yield on the Treasury notes outstanding was 2.6%, while the weighted average maturity was 3.6 years out. So it'll be pretty tough for higher rates to sneak up on the government all at once.

3. This level of debt is unprecedented. If you amend that to say "in the post World War II era," then yes, that is correct. Debt as a percentage of GDP was 83.5% at the end of 2009, a level not seen since we were paying off the debt incurred during the Second World War.

I wholeheartedly agree with debt hawks that we should focus on bringing debt down to a reasonable level. What I don't agree with is the idea that that will imperil economic growth. In 1946, debt was 121% of GDP, and 20 years later it was down to 34%. During that two-decade stretch, U.S. GDP expanded 721%, or roughly 11% per year.

Will we repeat that performance? Probably not, but it does suggest that growth can occur while bringing debt under control.

4. We're going to get crushed by taxes. We are going to see higher taxes down the road, but a big part of the reason taxes will increase is that we've been paying less than usual over the past few years. In 2009, total current tax receipts were 17% of GDP. Over the past 20 years, that number has averaged 20%.

5. The economy is being propped up by federal government spending. There's some truth here,  considering the fact that federal government spending as a percentage of total GDP has risen significantly over the past few years -- to 8% in 2009 from 6.9% in 2007. However, 2009's level isn't too far above the 7.2% average of the past 20 years and it's notably below the 9.4% average between 1981 and 1989 (the Ronald Reagan years, if I'm not mistaken).

This is a very polarizing issue, so I hardly expect that this data will convince everyone that the apocalypse isn't coming. Have some thoughts of your own? Head down to the comments section and chime in.

What does Fool Tim Hanson think is the biggest opportunity of the year? I'll give you a hint: It's not in the U.S.

Accenture and General Dynamics are Motley Fool Inside Value selections. Coach is a Motley Fool Stock Advisor pick. 

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


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  • Report this Comment On July 15, 2010, at 1:49 PM, jrkirk wrote:

    Finally, some logical talk on this subject. I agree completely with the author, and wish we could get more of the same thinking into this overall discussion. There is just too much shouting, and not enough logical talking, IMHO.

  • Report this Comment On July 15, 2010, at 2:19 PM, 5048 wrote:

    So.. debt came down after WWII while we had robust economic growth? Duh.

    There is another way: print more money and pay off the debt faster, while freezing non-interest government spending at current levels to avoid inflationary pressures. Concurrently devalue the dollar! This will alleviate the current account deficit, reduce the trade deficit and tilt the balance from imports to domestic production.

    Why aren't they doing this? Because the US is imprisoned by its failed free market ideology and unlike the USSR, there's no Gorbachev to pull the rug out from under the crumbling edifice.

  • Report this Comment On July 15, 2010, at 5:23 PM, mtracy9 wrote:

    Reagan said that deficits do matter and criticized Carter for them. Of course, Ronnie would become infamous

    for tripling the National Debt. Cheney changed Republican orthodoxy by saying that deficits don't matter.

    Cheney/Bush then went on to double the National Debt. Now that we have a Democratic President, Republicans

    are returning to the old orthodoxy, saying that deficits do matter.

  • Report this Comment On July 15, 2010, at 5:36 PM, mtracy9 wrote:

    Reagan said that deficits do matter and criticized Carter for them. Of course, Ronnie would become infamous

    for tripling the National Debt. Cheney changed Republican orthodoxy by saying that deficits don't matter.

    Cheney/Bush then went on to double the National Debt. Now that we have a Democratic President, Republicans

    are returning to the old orthodoxy, saying that deficits do matter.

  • Report this Comment On July 15, 2010, at 6:34 PM, PositiveMojo wrote:

    When I read your article it reminded me to check where consumers were in recovering from their debt binge that started in 2004 and ran through 2008 - being catalyzed by both the federal government and lenders.

    Consumer debt hit a of $2,561,000,000 in 2008 on a spending spree which started in 2004. Until 2004, consumer debt was growing at a rate that was comparable to the growth in the economy. Then credit card took off and reached the 2008 height in 4 short years. The result was that many consumers were absolutely crushed under credit card debt.

    The key question is, are consumers getting debt under control? In 2009, just one short year, they reduced debt to $2.448 trillion. That a $113 billion reduction in one year. It is also lower than the 2007 level but still higher than 2006. This means a lot of consumers are still under water but the financial condition of Americans is much better.

    In 2010 the current debt level is $2,415 trillion. That's an additional reduction of $33 billion in the first 5 months of 2010. At this rate we are likely to be another year or two getting back to normal historical levels. But this is clear evidence that the consumer is making progress and not just hyperbole.

    I also want to add that politicians have had no hand in this turn around. This is the hard work and sacrifice of the American Citizen to correct bad behavior. The numbers can be viewed at http://www.federalreserve.gov/releases/G19/Current/

  • Report this Comment On July 15, 2010, at 8:44 PM, xetn wrote:

    "We're going to get crushed by taxes. We are going to see higher taxes down the road, but a big part of the reason taxes will increase is that we've been paying less than usual over the past few years. In 2009, total current tax receipts were 17% of GDP. Over the past 20 years, that number has averaged 20%."

    NO, WE HAVE BEEN SPENDING MORE THAN WE TAKE IN!

    The fact is that the US has gone down the path of huge entitlements (unfunded SS, Medicare, etc. estimated to be $70 trillion dollars) and spending over $700 billion on wars. This Keynesianism on steroids. The idea that government spending creates jobs and expands the economy. But in reality, what it actually does it steal from the productive and gives to the non-productive (each according to their ability, each according to their needs.) Government does not produce anything and has no money to spend except that which it steals, prints out of thin air or borrows (debt).

  • Report this Comment On July 15, 2010, at 10:28 PM, donaldo15 wrote:

    All I know is that if you make $100k a year you cant spend $200k for very long without serious concequences. Lots of fancy alanlysis, but its kind of common sense isnt it?

  • Report this Comment On July 15, 2010, at 11:18 PM, snapperreef wrote:

    I believe that most T Bonds are not callable, so the treasury will have to continue to pay the original interest rate at issue. I can remember wondering why Carter and Reagan allowed non-callable bonds to be issued at those high 12-14 % rates in late 70s and early 80s.

    This same feature of course will help the Treasury Dept if rates go up but will kill the buyers in the secondary market.

  • Report this Comment On July 15, 2010, at 11:19 PM, TigerPack1 wrote:

    The only problem with this optimistic view of things, and it is unfortunately a gapping hole in the argument, is that the majority of our Treasury borrowing the last few years has come directly from ponzi FED purchases and massive buying by foreign central banks in Asia and Europe the... How much money did we borrow from Japan and China in WWII to get through that high debt to GDP period? ZERO Our debt used to be funded internally, from real savings, much like the Japanese experience the past 15-20 years.

    If we devalue the Dollar, foreigners will stop buying U.S. debt and our economy implodes from skyrocketing interest rates (to find the necesary capital inside the U.S. to fund our borrowing)... Or we can raise taxes and cut spending to slash the 10%+ of GDP deficit and the economy implodes... CATCH 22 will have a completely new meaning the next 6-12 months in America I fear.

    Alan Greenspan just did an interview today with Bloomberg saying we are screwed and he was an idiot for supporting the Bush tax cuts... He recommends we let the Bush tax cuts expire at the end of this year, thereby raising taxes annually by about $300 billion in 2011. Of course using standard mutipliers out there for the tax increase effect on the economy, this will reduce GDP by 3%-5% starting January 1. Given the economy will likely be growing by less than 2% at year's end, we will be in DEEP recession again by the 1st Quarter of next year.

    Please write more "wishful thinking" articles and keep your head in the sand... People like Soros, Greenspan, Buffett, Munger, Jim Rogers and about 500 other well respected market technicians and economists are filling the airwaves now that we are totally screwed because of the direction Congress and BEN at the FED have been taking U.S. the last 2 years... The writing is on the wall, the math is clear and undeniable... A huge finanical crisis is coming to America the next 6-12 months... I fear rioting in the streets will be a reality by spring. HEAVEN HELP U.S. all. I pray each night that I am wrong, by the way.

  • Report this Comment On July 16, 2010, at 3:01 PM, vanyah wrote:

    A Government Bubble == irrational exuberance for investing in government spending and government power to control or influence the economy.

  • Report this Comment On July 16, 2010, at 6:43 PM, ChrisBern wrote:

    Good article, but a few quick counter-thoughts. What was the net present value of our unfunded liabilities in 1946 versus today's? Ugly answer, I'm afraid. Were we a strong international producing economy in 1946? Yes. Are we today? No. What percentage of our deficit today is structural, versus in 1946? It's much more structural today, versus 1946 where the majority of the accumulated debt was due to the Depression and WWII. Will all of this debt lead to a collapse? Doubtful, to the author's point, but it's another big reason why I'm bearish on the S&P 500.

  • Report this Comment On July 18, 2010, at 7:59 PM, eongley wrote:

    Debt isn't just the only issue in what many observers, especially those outside the USA, say is the US death spiral promoted as much by a (currently) failed political system as it is by debt per se. China, where I spend a lot of time, firmly believes that the US is imploding and that the next century, if not before, belongs to them. They regard the past 100+ years of Chinese put-down by western powers as an anomaly that WILL be rectified and China WILL BE the next global superpower. There is all kinds of evidence to back up this theory -- loss of western led in many critical technologies, in green technologies, etc.. LIke it or not, the chinese political system is moving very quickly to a position of global economic dominance - just look at the past 20 years. It is also true that innovation is relatively low in China, education is not very good relative to western standards, health care is abysmal for 90% of the public, and corruption is eating away at the heart of chinese governance. Nevertheless, barring a political implosion, the US has much to fear in the next century or before -- most of it brought upon by American arrogance and denial.!! Not a pretty future.

  • Report this Comment On July 18, 2010, at 11:40 PM, noneyet wrote:

    That the country went from 121% of GDP in 1946 to 34% in 1966 with 11% annual increases in GDP is not the situation that we face. Economic growth in the next decade is going to be much lower absent huge govt. money printing....which will be the political situation which absolutely cannot tolerate sustained deflation.

    The OBama projections for gdp growth ( never mind the admitted huge increases in budget deficits each year) include: no recessions! continuation of very low interest rates! ignoring the huge structural changes in employment, downward pressure on real wages etc. Our economy will be lucky to grow at 3.5% even given the jiggered GDP deflator that consistently over estimates real GDP by ~ 2% a year .Unless, of course, we open or borders to a huge wave highly skilled of immigrants....care to guess the skill/education levels of the last 11 million?

    Matt, the miracle of compound interest in investments....also compounds growing debt on the way to financial ruin........

    Planning to emmigrate anyone?

  • Report this Comment On July 25, 2010, at 11:09 AM, halfbeer wrote:

    I like America and want to stay here, but we need to vote for fiscally responsible candidates in all future elections and need to put our money in a safe place for the upcoming months and years.

    I understand that the author is trying to ensure that people stay in the market (for obvious reasons- it is fool.com and that is the business). I believe that investment and capitalism are key and cornerstone, but I think that we'd listen a lot harder if you told us where everyone could put their money that would survive possible economic collapse. Perhaps a "safe" currency in a bank savings account?

    Comparison of Debt to GDP has been fine as long as GDP wasn't affected severely and adversely by the economy also. I notice you don't mention specifically that we racked up the majority of our national debt of 13+ trillion USD over the last 30 years and that our national debt is basically is looks like an exponential curve starting to shooting straight up over the last few years much faster than during the 80s and first part of the 2000s. Anyone with common sense can see we are headed for something awful.

  • Report this Comment On April 07, 2012, at 8:51 PM, 9404estee wrote:

    Just like the fool to CandyCoat Everything.

    Do you Know that According to the U.S. Triasury, 40 cents out of every dollar the federal government spends is borrowed. We are not just borrowing from China; we are stealing form our grandchildren. 2011 marks the third straight year of deficits exeeding a trillion dollars. Our children and grandchildren will inherit the worst economy in our country's history. The U.S. Dollar is a house of cards, get ready for high inflation and hard times.

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