This is a post about the U.S. national debt. It is an emotionally charged topic, and you probably have your own preconceived – perhaps closely held – beliefs. So I am going to begin by discussing… condos.
Specifically, the most expensive luxury condominiums money can buy. That is, Billionaire’s Row, the striking pencil-thin residential skyscrapers on the southern end of Central Park in Midtown Manhattan. If you are unfamiliar with the engineering, run a quick Google search. The units in these architectural marvels sell for nine figures. Other than exorbitantly priced suites, these skyscrapers have three commonalities – miraculous height to width ratios, the most valuable location on the globe, and… they are mostly empty.
Opulent condominiums with pristine views in the economic center of the universe are unlikely to lose value. Buyers of these nine-figure condos overlooking Central Park aren’t looking for a place to sleep at night. They are looking for a place to store their money. Functionally, the condominiums on Billionaire’s Row more closely resemble a Monet than they do a home. An appreciating asset with bragging rights. If you have $100,000,000 laying around you can put it in a high yield savings account (probably many different high-yield savings accounts for risk management reasons), earn ~4.5%/yr. in interest ($4,500,000), pay taxes at 37+% ($1,665,000 annual tax bill – especially annoying because you’re not spending the $4.5M interest income, you’re rolling it in the savings account) and receive no additional utility.
Or you could buy one of the nicest condos in the world in the most valuable location on the planet, allow it to appreciate over time and either borrow against it tax-free or sell and pay capital gains taxes (lower rate than income taxes) should you need liquidity, all while enjoying the fringe benefits of a lavish pied-à-terre. This is why the most expensive condos on the globe are largely uninhabited. They are not a place to live. They are a place to store wealth.
The global financial system is awash in money. This can be difficult for you and I to conceptualize as we (or at least I) wonder where all our money has gone by the end of the month. We live our day to day in the economic micro. But in the aggregate, the global macroeconomy – sovereign nations, multinational corporations, institutional investment pools of capital, wealthy individuals – is awash in money and constantly searching for a place to store it.
Luxury real estate is one option, though it has the downsides of limited availability, liquidity, and carrying costs. Van Goghs, Monets and other collectibles have the same pitfalls. Gold has some benefits, though it is not easily transported, costly to store, and its price is surprisingly volatile. There is one asset that works wonderfully. It is readily marketable, instantly convertible to the world reserve currency (which can then be readily converted at a known exchange rate to any currency the owner desires), carries no risk of loss of principal, incurs no carrying costs, and makes guaranteed interest payments. I am referring, of course, to U.S. Treasury bonds.
Which, by the way, is what people are referring to when they mention the “national debt.” “U.S. National Debt” and “U.S. Treasury Bonds” are two ways of saying the same thing. It’s funny how one has such a negative connotation and the other’s is generally positive, isn’t it? You may find discovering why a helpful exercise.
I cannot cite any research here, but I am certain there is no asset with a more diverse ownership base than U.S. Treasurys. Governments, individuals in the U.S. and abroad, pension funds, banks, private equity funds, non-profits, trusts, other institutions… all own US Treasurys. That is, the “national debt” may be a liability on the balance sheet of the United States, but it is an asset on everyone else’s (including likely your own).
People say things like “we owe China 700 billion dollars,” and our minds conjure up images of a poor debtor forced into subservience to a powerful creditor. This is not a happy image, especially when the debtor is us and the creditor is China! Thankfully, this mental model lacks context; that is, China buys Treasurys (our debt) because it needs Treasurys. If we suddenly paid China back in full, they would beg us to buy more Treasurys. China’s entire manufacturing-based export economy breaks down if they can no longer operate as a creditor of the United States. They require a weak local currency (yuan) to make their exports competitive globally. When the yuan is weak relative to the dollar, Chinese exports are more competitive for buyers paying in dollars (hence all the Made in China stickers). US consumers pay for Chinese goods in dollars, and Chinese firms convert the dollars to yuan to pay their workers and operate in their local economy. The PBOC (Chinese central bank) buys up all these excess dollars from the exporters (paying them yuan in exchange) in its explicit currency intervention program to weaken the yuan against the dollar (because their economy depends on it). So, the PBOC finds itself hoarding vast reserves of U.S. dollars, creating a massive need to buy US Treasurys.
Our mental model requires inversion. The fact that China holds a massive amount of our national debt is a symbol of the strength of the U.S, not of China.*
When evaluating the sustainability of the national debt, people focus on the topline number. We owe $35 Trillion – that’s bad! Like all univariate analyses, this is incomplete. What matters is not the total balance but the cost to service the debt as a percentage of GDP. If I make $50K/yr and owe $1,000,000 I am in trouble. There is a reason banks won’t write seven figure mortgages for people making $50K/yr. If I make $1,000,000/yr. and owe $1,000,000 on the mortgage, it may be time to consider buying a nicer house. Servicing a $1M debt balance is not a problem on a reliable annual income of $1M.
America is unique in that we can and have for nearly the entirety of the post-WWII era, pay a lower interest rate on our debt than the rate at which our economy grows.[i] Notice the mathematical implication - America’s ability to increase her economy at a faster rate than what she owes to service her debt allows her debt service-to-GDP ratio to melt away. That is, even as the topline ($35 Trillion!) debt balance grows, the real debt burden subsides. U.S. debt is unique among sovereign debt in this manner for the same reason the condos on Billionaire’s Row are empty: people, countries, and institutions want to own America’s debt because it provides safety and liquidity for their assets, not for the rate of return it pays. Thus, the US can borrow and watch her debt slowly shrink relative to the size of her economy.
In 1946, President Truman’s Council of Economic Advisors warned him the country faced “a full-scale depression some time in the next one to four years” largely due to the unprecedented national debt resulting from our WWII spending binge.[ii] At that time, the national debt was $269 billion, or 119% of GDP. Today the national debt is $35.7 trillion, or… 120% of GDP. More importantly, here is the cost to service the debt as a percentage of GDP:[iii]
History proves Truman’s economic advisors woefully mistaken. Rather than a Great Depression, the post-war United States built the greatest economic powerhouse the world has ever seen. By 2020, the cost to service the debt as a percentage of GDP was lower than it was when Truman’s advisors issued their infamous warning. I suspect his advisors would have been horrified to learn the national debt would rise to $35 trillion by 2024. Though they likely would have been more stupefied to learn our GDP would exceed $29 trillion. Admittedly, the chart above shows the cost to service the debt has risen since 2020, but historically it remains at manageable levels and fluctuation is normal. Interesting how often people screech about the $35 trillion national debt and how rarely they mention the miracle that is a $29 trillion economy.
In our office, we created the “Resolute Wall of Infamy” where we have framed the covers of magazines blaring catastrophist headlines over the years (this is a new project - if you haven't seen it yet please stop by!). One entrant comes from Time with the title That Monster Deficit – America’s Economic Black Hole from March 5, 1984. I find it a bit amusing that on that date the interest on the national debt as a percentage of GDP was 2.75% compared to 2.37% today. And for anyone thinking of adjusting their investment policy based on the national debt – the S&P 500 closed at 157.89 on the date of that article. Today it closed at 5,842.47.[iv]
The national debt is often – mistakenly – anthropomorphized. As individuals, we seek to pay our debts before we die. We do not want our heirs to inherit our debt, and we wish to avoid a high debt burden in old age when our capacity to earn income diminishes. America is not a person. She has no expiration date (at least, if she does we don’t know when it is and at that point her debt will be irrelevant), and her income (GDP) will continue to expand (again, if that does not prove to be the case, the debt will be irrelevant). She does not have to pay off her debt, she only needs to manage it as she has historically with surprising aptitude.
Is this state of affairs sustainable? As is true of everything, no one can say with certainty. Will US Treasurys remain so attractive globally the US can continue paying interest rates beneath the growth rate of the economy? There is presently no indication this will change in the short run. King Dollar’s status as the world reserve currency is as secure as ever.** Will the government run up the deficit so massively or mismanage the economy so poorly that borrowers demand interest rates in excess of economic growth rates for an extended period? Perhaps, but this has yet to be the case despite eight decades of economists’ and pundits’ fears. History has been kind to those whose faith in the ingenuity of the private sector outweighed his fears of the government’s ability to strangle it. Though anything is possible in the long run. Certainly no 18th century Brit ever conceived his geopolitical power would someday be usurped by those pesky colonists across the pond. For now, anyone stirring fears of the national debt is either ill-informed, trying to sell you something, or pushing a political agenda (or some combination).
I fear this post will be misinterpreted. I am not a fan of passing multi-trillion-dollar spending bills so we can “see what’s in them.” The dynamics explained above do not give policymakers in Washington unchecked license to spend. Reserve currency status does not mean we can run unlimited deficits, and prudence amongst policymakers is vanishingly rare in Washington. As noted above, the reason the U.S. can run deficits without damaging its economy is the American private sector is the greatest engine of wealth creation ever conceived. American businesses have engineered economic growth allowing Uncle Sam’s debt service to melt away as a percentage of GDP. A little respect – rather than more taxes and regulation – for those of us in the private sector who do the work to make this whole system sustainable would be appreciated (I’m not holding my breath). But I do take issue with those fearmongering about the national debt. $35 Trillion is a big number and it’s easy to sell people on both sides as the apocalypse du jour. Debt service is ~2.5% of GDP while we spend ~20% on healthcare, but the only proposals for healthcare reform I hear suggest spending more money. I wonder why that is…
Remember the empty condominiums overlooking Central Park. The national debt balance is large and will continue to rise because of the world’s insatiable appetite for US debt. If America for some reason repaid her debt, nearly every country and global institution would beat down her doors begging her to borrow more. US Treasurys are the ideal asset to store wealth in the global economy. They are the holding vehicle for U.S. dollars, the currency required to participate in the economic engine that drives the world. This summons one of our cherished investing principles:
Never, ever bet against America.
Sean Cawley CFP®
*Some make the argument China will dump US Treasurys in the event of rising hostilities. Often this prediction accompanies conjecture of a Chinese invasion of Taiwan. They’ll use our debt they own to manipulate us into doing their bidding when they invade Taiwan and takeover global semiconductor manufacturing! This is akin to arguing China will prepare for war by committing economic suicide. If people didn’t take this imaginary risk so seriously it would almost be amusing.
**The media loves scaring people about this, too. Please read: https://www.resolutewealthmanagement.com/blog/de-dollarization-or-not
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[i]https://www.milkenreview.org/articles/federal-debt?IssueID=53
[ii]https://collabfund.com/blog/who-pays-for-this/
[iii]https://fred.stlouisfed.org/series/FYOIGDA188S
[iv] YCharts, ^SPX, Data, October 16, 2024.