The late Herb Stein popularized this saying.[1] If I may elaborate a bit, the idea is that if a process, activity, or anything else can’t possibly go on forever, it must eventually stop. Today I want to talk about the rising U.S. government debt. If it can’t go on forever it will stop.
Herb Stein
Governments can (and sometimes do) default on their outstanding debt. That means missing a contractual payment when it is due. These payments include coupon payments (sometimes incorrectly called interest payments) and repayment of the bond’s face value when it matures. A government default is called sovereign default. (For those unfamiliar with how bonds work, I’ve written about it here.)
In fact, that’s what Dr. Stein was talking about. Here’s the actual quote (emphasis added).
Mr. STEIN. Well, I recently came to a remarkable conclusion which I commend to you and that is that if something cannot go on forever it will stop. So, what we have learned about all these things is that the Federal debt cannot rise forever relative to the GNP. Our foreign debt cannot rise forever relative to the GNP. But, of course, if they can’t, they will stop.
In the case of the Federal debt, there may not be a mechanism. In the case of the foreign debt, which is essentially private debt, it will stop when the rest of the world doesn’t want to hold it any more. It will stop rising, and when it stops rising the dollar will decline and we will stop running this big balance of trade deficit.
Herb got it backwards. The U.S. pays for a current account deficit[2] by running a financial account surplus.[3] That means foreigners buy more U.S. assets than U.S. people and institutions purchase assets in foreign countries. But some economists have hypothesized that the U.S. has a comparative advantage at producing assets. In which case, the current account balance can remain in deficit indefinitely (apologies).
The Cause of Government Default
Government default occurs when the government can no longer raise funds by borrowing in the debt market. That means they can’t roll over existing debt that has matured or they can’t cover coupon payments when they are due. As long as the central bank is independent, the government cannot solve this problem by printing money. If the central bank decides to monetize the debt by purchasing most of the newly-issued government securities, the short-run risk of default is reduced. But eventually this will lead to hyperinflation, increases in the average price level of 50% per month. Since the price level grows at a compounded rate, the annual inflation rate is about 13,000%.
A major contributing factor to the risk of government debt is the ability of the government to make coupon and principal payments. A quick and dirty metric is the ratio of government debt to GDP. As always, my methodology is transparent. Click here to download my Excel workbook. Added bonus: a complete listing of all sovereign defaults and the history of the composition of U.S. government receipts and expenditures.
Argentina has defaulted nine times.[4] The first was 1827. The most recent was 2020. In fact, Argentina was pretty much in default for the entire decade leading up to 2020. It’s first official default during that period was 2014. Here’s what the country’s debt to GDP ratio looked like. (Argentina spent most of the decade negotiating with owners of its debt in an effort to persuade them to restructure the terms. That accounts for the decrease in the debt to GDP ratio in the last half of that decade.)
Figure 1 Argentina debt to GDP ratio. Source: Federal Reserve Bank of St. Louis FRED database. (click for larger image)
When the debt to GDP ratio surpassed 140% in 2002, trouble was on the horizon.
By contrast, the United Kingdom is relatively staid:
Figure 2 UK debt to GDP ratio. Source: Federal Reserve Bank of St. Louis FRED database. (click for larger image)
Now let’s look at the U.S.
Figure 2 US debt to GDP ratio. Source: Federal Reserve Bank of St. Louis FRED database. (click for larger image)
.That sharp increase on the right side of the chart is worrying.
How Long Can the US Continue Borrowing?
The most frightening phrase in the minds of Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell is “failed Treasury auction.” That would mean there were not enough private buyers for U.S. government debt. It also implies the Fed is unwilling to monetize the debt. The only way to induce those private buyers back into the market is to compensate them for the increased risk of U.S. securities. That means raising the rate of return (interest rate) on the debt.
As of July 31, 2021, U.S. government debt held by the public was $22,353,532.000,000 (22.353 trillion dollars). A one percentage point increase in the interest rate paid on that debt will increase interest payments by $223,535,320,000 (223.535 billion). Currently total net interest payments on the debt are $344.7 billion. It’s about 1/3 of the total defense budget ($726.2 billion). And that’s for a single percentage point increase in the interest rate.
Let’s return to Dr. Stein’s dictum. The U.S. government cannot continue to increase its debt without a limit. Therefore, eventually, the increases in debt must stop. I don’t know when. We’re in uncharted territory here. But the warning signs are there. Sadly, Congress will have to learn this lesson the hard way.
- Stein, Herb (1986). “A Symposium on the 40th Anniversary of the Joint Economic Committee,” Hearings Before the Joint Economic Committee, Congress of the United States, Ninety-Ninth Congress, First Session, January 16 and 17, 1986, Panel Discussion: “The Macroeconomics of Growth, Full Employment, and Price Stability,” Speaker: Herb Stein, Quote Page 262, U.S. Government Printing Office, Washington D.C. (HathiTrust Full View) Available at https://hdl.handle.net/2027/umn.319510030778307?urlappend=%3Bseq=270. Accessed November 1, 2021. ↑
- The current account balance includes the balance of trade, imports minus exports. Many confuse the two. But the current account balance also includes items such as remittances, income earned by residents of one country and sent to residents of another country. ↑
- The financial account was once called the capital account. It measures financial transactions among countries. ↑
- Ben Bartenstein and Marisa Gertz (September 11, 2019). “One Country, Nine Defaults: Argentina is Caught in a Vicious Cycle.” Bloomberg.com. Available at https://www.bloomberg.com/news/photo-essays/2019-09-11/one-country-eight-defaults-the-argentine-debacles. Accessed November 6, 2021. ↑
