America’s real debt crisis

The exponential rise of debt is stifling its economic growth. It thus takes ever more dollars of debt to generate an extra $1 of GDP.
Chris Leithner

Leithner & Company Ltd

In Fortune magazine on 22 November 1999, Warren Buffett recounted to Carol Loomis: “Someone once told me that New York has more lawyers than people. I think that’s the same fellow who thinks profits will become larger than GDP. When you begin to expect the growth of a component factor to forever outpace that of the aggregate, you get into certain mathematical problems.”

Today, many people are committing an analogous error: they apparently assume that America’s borrowings can indefinitely grow faster than its overall economy. Moreover, and despite its increasingly heavy load of debt, they believe that the U.S. economy can continue to expand vigorously. Indeed, some insist that an even more rapid rise of the ratio of debt to GDP will “stimulate” growth.

But what Buffett said a quarter-century ago about profits remains true today about leverage: when you expect a component indefinitely to outpace the aggregate, at some point you’ll encounter insuperable difficulties.

This article summarises the seemingly inexorable growth of America’s debt. It also details three resultant major problems: 

  1. Led by the ongoing explosion of federal government expenditure, America’s total (that is, the sum of corporate, federal government and household) debt is rising exponentially, whereas its economy is growing linearly; as a result,
  2. Over time it takes ever more dollars of debt to generate an extra $1 of GDP. Since the 1960s the marginal productivity of debt has fallen steadily – and cumulatively drastically. Accordingly,
  3. Rising debt, led by exploding federal government debt, is now stifling GDP growth.

In response to these developments, America’s economic, financial, political and above all cultural consensus is astonishingly complacent. Indeed, it’s wildly optimistic to the point of wilful blindness and gross irresponsibility to assume that debt as a percentage of GDP can rise indefinitely. The choice is stark: Americans must either undertake radical budget reform and debt deleveraging, or accept continued economic stagnation – and if current trends worsen, eventually risk a debt crisis. They categorically refuse the former, so they blithely accept the latter.

Never mind today’s posturing around the “debt ceiling” —at best it’s an amusing sideshow and at worst it’s a dangerous distraction. The bickering is, however, a symptom. Its proximate cause is the federal government’s insatiable spending; and its ultimate cause is the widespread repudiation within the U.S. (and throughout the Western world) of the ethos that underpins self-government and prosperity.

What Is the “Debt Limit”?

“The debt limit,” says the U.S. Treasury, “is the total amount of money that the United States Government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. The debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past.”

Under Article I, Section 8 of the Constitution, Congress must and only Congress can authorise the executive (in practice, the Treasury) to borrow money for public purposes. Until 1917, Congress approved each issue of U.S. Government debt. To provide more flexibility to finance the country’s entry into the First World War, in the Second Liberty Bond Act (1917) limited on the total amount of bonds that the Treasury could issue. Periodic amendments to the Public Debt Act (originally passed in 1939) lift the ceiling.

“Since 1960,” Treasury adds, “Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. Congressional leaders in both parties have recognized that this is necessary.”

“Failing to increase the debt limit,” Treasury alleges, “would have catastrophic economic consequences. It would cause the government to default on its legal obligations ... (Such a default) would precipitate another financial crisis and threaten the jobs and savings of everyday Americans – putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession.”

From a purely logical point of view, Treasury’s allegation is just plain silly. When the U.S. Government approaches the debt limit that Congress has set, there’s no logical reason why it must borrow even more: instead, it can simply reduce its expenditures! Congress could enact legislation that dismissed bureaucrats and slashed their salaries, closed and merged departments, pruned Medicare, Social Security and other “entitlements,” trimmed the military, privatised vast swathes of the government, etc.

Of course, none of these things are remotely likely to happen. Nor would they occur if Republicans occupied the presidency and held majorities in both houses of Congress. Indeed, such a confluence of events occurred as recently as 2016 – and the federal government’s debt continued to skyrocket. 

Each time the feds’ debt approaches its limit, there’s a political – indeed, cultural – reason why Washington must borrow ever more: Leviathan and his underlings indignantly refuse to live within their means. Yet DC’s profligacy is unique. Whether according to their constitutions or legislation, almost all (48 of 50) U.S. states must (and, in practice, do) balance their budgets; as a result, their finances are largely in reasonable shape – and, as we’ll see, their debt is moderate and falling. Why can’t the feds do likewise?

In a crucial respect, it’s utterly false to assert that the U.S. is culturally and politically divided. Quite the contrary: the consensus that its federal government must live well beyond its means is broad and deep. Even to suggest that its budget return to balance and that debt’s rate of growth decelerate is denounced as heresy; and to propose that the budget return to surplus and that debt be pruned enrages the consensus into spasms of apoplexy.

Three unspoken but fundamental assumptions thus underpin the Treasury’s assertion that any failure to lift federal government’s debt limit would have “catastrophic economic consequences.” First, neither empirically nor morally is there any need to balance the federal government’s income and expenditure – and there’s every justification to run an enormous deficit (presently $1.4 trillion, which exceeds 7% of GDP; the Congressional Budget Office projects that from 2024 to 2033 it will average $2 trillion per year in current dollars.) The consensus is adamant: massive and rising deficits can and should continue indefinitely. Second, and given assumption #1, there’s no ethical or factual need to restrain the U.S. Government’s borrowing: it too can increase indefinitely.

As a result, and thirdly, the consensus will abide no logic or evidence: whenever the federal government’s debt approaches its ceiling, it simply must be lifted. Better yet, the inconvenience – indeed, the very idea – of a limit should be abolished so that the feds can borrow without let, hindrance or limit.

The Latest Debt Ceiling Punch and Judy Show

On 19 January, the Treasury Secretary, Janet Yellen, estimated and earlier this month reiterated that Washington had reached its current debt ceiling (approximately $31.4 trillion), and that without an increase of the limit it could pay its bills only through early June. As it’s often done when previous ceilings loomed, it’s undertaken “extraordinary measures” to push this “X-date” as far into the future as possible. (If the X-date arrives without an agreement to lift the cap, Treasury will be unable to issue additional debt securities and can only make payments from incoming tax revenues – which, given the huge deficit, are woefully inadequate to meet all obligations including debt).

On 26 January, Joe Biden smeared Republicans as the party of “chaos and catastrophe.” Specifically, he denounced their refusal to increase the ceiling unless they and the administration agree to trim the budget’s huge deficit. In his rant, Biden alleged that the GOP’s proposal is “dangerous for the economy.” Hence he and his Democrat colleagues in Congress refuse to negotiate: instead, last week they continued to demand that Republicans in Congress lift the ceiling without conditions. Indeed, Biden has dubbed the stance of the Speaker of the House, Kevin McCarthy, as “mind-boggling.” “I will not let anyone use the full faith and credit of the United States as a bargaining chip. In the United States of America, we pay our debts,” the president vowed.

Tellingly, according to analysis summarised in The Wall Street Journal (9 May), both the President’s budget proposal for 2024 (which the House won’t enact) and the House Republicans’ debt ceiling bill (which will fail in the Democrat-controlled Senate) would increase the ratio of the federal government’s debt to GDP – the former much more than the latter. In truth, it’s Biden’s stance that’s mind-boggling: any proposal which boosts the ratio less than his is apparently “dangerous for the economy”!

To be charitable, perhaps dementia or senility has destroyed Biden’s memory. Less generously, his mental faculties are unimpaired and he remains what he’s consistently been: a blatant hypocrite. On 17 November 2004 (when the ratio of federal government debt to GDP was half of what it is today), according to The Congressional Record, the then-Senator Biden correctly stated that “today’s fiscal mess ... is not an accident. It is the inevitable outcome of policies that consistently ignored evidence and experience ... Many of us in Congress argued that we could not afford to do everything, that we needed a fiscal policy that matched our revenues with our expenditures …”

For good measure, Biden added more home truths: “we are here today because (prudent) advice was ignored, hard choices were ducked, and the bill for our decisions will be sent to our children and grandchildren, in the form of the additional debt we will authorize today. It did not have to be this way ... My symbolic vote against raising the debt limit (is) a protest of the policies that have brought us to this point, and a demand that we change course.”

Biden of 2004 sounds uncannily like Kevin McCarthy and other “extremist” Republicans of today! Yet there’s more. On 16 March 2006, Senator Biden declared: “There is just so much of our debt other nations want to hold. The more of it they accumulate, the closer we are to the day when they will not want any more. When that happens, slowly or rapidly, our interest rates will go up, the value of their U.S. bonds will drop, and we will all have big problems. We need both more awareness, and more understanding, of this fundamental threat to our economic wellbeing and the global economy ... Because this massive accumulation of debt was predicted, because it was foreseeable, because it was unnecessary, because it was the result of wilful and reckless disregard for the warnings that were given and for the fundamentals of economic management, I am voting against the debt limit increase.”

After voting as a senator no less than 10 times against raising the debt limit during Republican administrations, President Biden now contends that it’s “mind boggling” to risk defaulting on obligations by failing to increase the ceiling! As Vice President in 2011, Biden urged compromise and criticised a “my way or no way” approach to the ceiling; today, he champions intransigence. And he’s not the only Democrat suffering from partisan selective memory: the Senate Majority Leader, Chuck Schumer, voted against raising the debt limit three times under George W. Bush but now demands a “clean” debt ceiling increase with no negotiations on spending cuts! More generally,

  • in 2006, every Democrat in Congress voted against raising the debt limit;
  • in 2004, all but two Democrats voted against raising the debt limit;
  • in 2003, all but three Senate Democrats voted against raising the debt limit.

The charade is as obvious as it is childish: when Party X occupies the White House and America’s debt approaches its legal limit, Party X demands that Congress lift the ceiling. If Party X also controls Congress, it meekly complies; if Party Y does, then it demands concessions – but often folds its hand rather than incur the wrath of public and elite opinion. Usually the ceiling rises without too much fuss; but occasionally, as in 2011, when S&P downgraded its rating of the U.S. Government’s debt securities from AAA to AA+, ructions flare and financial markets rumble.

America’s Corporate, Government and Household Debt

Using data collated by the St Louis branch of the Federal Reserve System, Figure 1 plots total corporate, federal government, household and state/local government debt in the U.S. since 1952. These amounts have been adjusted for the Consumer Price Index (2022 = 100). Corporate debt measures the market value of all debt securities issued by, and the loans of, non-financial corporations; government debt measures the value of all relevant government debt securities; household debt includes personal and mortgage loans but seems to exclude student loans. Total debt is the sum of these components.

Figure 1: Major Components of Total U.S. Debt, CPI-Adjusted Trillions of $US, Q1-1952 to Q4-2022

Corporate debt has risen from $0.47 trillion in 1952 to $7.55 trillion in 2022. It rose as high as $8.3 trillion in April of 2020, but since then has decreased 9.5%. Household debt has risen from $0.97 trillion in 1952 to $18.9 in 2022. It scaled its maximum ($20.3 trillion) in Q3-2007, but since then has sagged 7.1%.

State and local government debt has climbed from $0.29 trillion in 1952 to $3.26 trillion in 2022. It reached its maximum ($3.92 trillion) in Q3-2015; since then, it’s plunged 17%. Federal debt, on the other hand, has zoomed from $2.2 trillion in 1952 to $26.9 trillion in 2022. It reached its maximum ($27.5 trillion) in Q1-2021, but since then has decreased 2.5%. Finally, total debt has risen from $3.9 trillion in 1952 to $56.5 trillion in 2022. It attained its maximum ($58.5 trillion) in Q3-202, but since then has decreased 3.4%.

Bear in mind that these series measure debt’s market value – and that sharp rises of interest rates crimp these values. Hence the reduction of corporate, government and household debt over the past couple of years doesn’t indicate ebbing indebtedness; it reflects the lower valuation of debt arising from sharply higher rates of interest.

It’s also important to understand that, contrary to some assertions, during the 30 or so years after 1952 the U.S. Government didn’t repay a penny of federal debt: in nominal terms (that is, not adjusted for CPI), aggregate debt zoomed from $190.6 billion in 1952 to $1.3 trillion in 1982. That’s a CAGR of 6.6%.

As old bonds (incurred to finance relief during the Great Depression and victory in the Second World War) matured, Treasury “repaid” them by issuing new ones. Moreover, additional borrowing financed the budget deficits incurred during these years. Adjusted for CPI (whose compound annual growth rate was 4.4%), the federal government’s debt rose from $2.2 trillion to $3.5 trillion (CAGR of 1.6%). During these years and net of CPI, the federal government’s debt thus grew modestly (CAGR of 0.6%).

Since the early years of the century, however, the trends have been very different. In nominal terms, the feds’ debt has exploded from $1.3 trillion in 2002 to $26.9 trillion in 2022; that’s a CAGR of 10.7%. Adjusted for CPI, debt has risen from $3.5 trillion in 1982 to $26.9 trillion in 2022; that’s a CAGR of 7.0%. During these years, CPI’s CAGR was 3.8%; consequently, federal government debt has grown much more rapidly than CPI.

Figure 2 plots the four components as percentages of total debt. Corporate’s share has been remarkably stable: it’s always exceeded 10% but never exceeded 20%. So too state and local government debt: it’s never exceeded 13% of the total, and during the past 15 years has continuously fallen, reaching an all-time low of 6% since 2020.

Figure 2: Major Components of U.S. Debt as Percentages of Total Debt, Q1-1952 to Q4-2022

The federal government’s and households’ shares of total debt have varied inversely. The feds’ share fell steadily from 56% in 1952 to 30% in 1980; during that interval, household debt’s share increased from 25% to 45%. From 1980 to the eve of the GFC, the feds' share sagged further (to 27% in 2007) and household debt’s share continued to rise (to 51%). Since the GFC, however, household debt’s share has collapsed (to 32% in 2022, its lowest share since 1956) and the federal government’s share has zoomed (to 48%, its largest share since 1956).

In the 1950s, bearing the scars of the Great Depression, Second World War and Korean War, the federal government’s share of total debt exceeded households’ share; from the 1960s to the GFC, notwithstanding the Great Society and War in Vietnam, households’ share exceeded the federal government’s; but over the past 20 years, as a consequence of exploding federal deficits, its share again exceeds households’.

Figure 3 plots America’s total debt and its components as percentages of Gross Domestic Product (GDP). During the 30 years to the early-1980s, the ratio of total debt to GDP was remarkably stable. Equally clearly, a ratchet effect is evident: the ratio rose rapidly during the 1980s and stabilised in the 1990s; it again rose rapidly in the 2000s and stabilised in the 2010s; and zoomed in 2020 but has retraced much of this jump.

As a result, America’s ratio of total debt to GDP is more than twice as high today as it was 40 years ago.

Figure 3: Major Components of Total U.S. Debt as Percentages of GDP, Q1-1952 to Q4-2022

What explains the doubling since the 1980s of America’s total debt relative to GDP? For a time, state and local government debt made a minor contribution: its ratio of debt to GDP climbed erratically from 12% in 1980 to 20% in 2004 – and thereafter sagged steadily to 12%. Corporate debt has contributed: its ratio to GDP has risen steadily from 11% in 1952 to 29% in 2022. Until the GFC, the rising ratio of total debt to GDP was largely the result of the rise of household debt to GDP; this ratio rose almost without interruption from 24% in 1952 to 99% in Q1-2008. Since then, however, households have deleveraged significantly: today, the ratio of household debt to GDP is 73%.

For the 30 years to the 1980s, the ratio of federal government debt to GDP fell (from 53% in 1952 to 31% in 1974, where it remained for the next 10 years). The ratio rose as high as 58% in 1993, but then fell as low as 39% in 2001. Thereafter it rose in fits and starts but cumulatively massively, to as high as 117% in 2020. Ironically, the sharp rise of interest rates over the past couple of years has caused the value of the federal government’s debt to fall: its ratio to GDP thus sagged to 104% in 2022.

The rise of America’s overall leverage during the half-century to the GFC was primarily the consequence of rising household debt; since then, it’s mostly been the consequence of rapidly rising federal government debt.

The First Crucial Result

In Figure 1, during the half-century to 2002, the federal government’s debt’s CAGR was 2.5%; since 2002, it’s been 6.7%. An exponential function fits the federal government debt series significantly better (R2 = 0.95) than a linear one (R2 = 0.77); but exponential models don’t fit the other data significantly better than linear models. Linear growth occurs by adding the same amount (say, 2) during each unit of time, e.g., 100, 102, 104, 106, etc. Exponential growth occurs when an initial amount increases by the same percentage (say, 2%) per unit of time, e.g., 100, 102, 104.04, 106.12, 108.24, etc.

Over time, an exponential series increasingly outpaces a linear one. Figure 4 (which plots CPI-adjusted GDP and total debt) and Figure 5 (which plots CPI-adjusted per capita GDP and total debt) depict this crucial point.

Figure 4: GDP and Federal Debt, Trillions of CPI-Adjusted $US, Q1-1952 to Q4-2022

From 1952 to the early-1980s, CPI-adjusted GDP and total debt closely approximated one another, i.e., the ratio of total debt to GDP was ca. 100% (Figure 3). Over the past 40 years, however, debt’s CAGR has greatly exceeded GDP’s; as a result, the ratio of total debt to GDP has accelerated almost without interruption.

Figure 5: Per Capita GDP and Federal Debt, Thousands of CPI-Adjusted $US, Q1-1952 to Q4-2022

The Second Crucial Result

The World Bank (“Finding the Tipping Point – When Sovereign Debt Turns Bad,” 22 June 2013) concluded from its study of scores of countries since the 1980s that those whose ratios of debt-to-GDP exceed 77% for prolonged periods also experience significant slowdowns of economic growth. Specifically, every percentage point above this level costs these countries 0.017 percentage points of GDP growth.

Given that the federal government’s total debt is now ca. 100% of GDP (Figure 3), we have (100-77%) × 0.017 = 0.40 percentage points. In other words, given its heavy load of government debt, what in the past might have been GDP growth of 3.0% now becomes 2.6%.

Using data from 54 countries from 1990 to 2015, the Bank of International Settlements (“The Real Effects of Household Debt in the Short and Long Run,” BIS Working Paper No. 607, 26 January 2017) concludes that “household debt boosts consumption and GDP growth in the short run, mostly within one year. By contrast, a 1 percentage point increase in the household debt-to-GDP ratio tends to lower growth in the long run by 0.1 percentage point. Our results suggest that the negative long-run effects on consumption tend to intensify as the household debt-to-GDP ratio exceeds 60%.”

Given that the ratio of household debt to GDP is presently 73% (Figure 3), we have (73-60%) × 0.01 = 0.13 percentage points. Given America’s heavy load of government debt, what in the past might have been long-run GDP growth of 2.6% becomes (as a result of its load of household debt) 2.47%.

These generalisations describe the situation in the U.S. I computed the 12-month change of GDP since 1953; in order to reduce the volatility of these short-term changes, and also to estimate a medium-term figure, I also computed the mean of 12-month changes over five years; Figure 6 plots the results. As time has passed (and debt has risen), the growth of CPI-adjusted GDP has stagnated.

Figure 6: Annualised Growth of CPI-Adjusted GDP, Five Year Average, Q1-1952 to Q4-2022