Is the US in Trouble from a National Debt Perspective: Could the US Default?
Ultimately, this is the crux of the national debt issue. In our view, the answer is emphatically no—the US is not a credit risk at present. There are three key reasons underpinning our view. First, the US can afford to pay its debts and can easily service the interest on its debt (See slide 5). Moreover, the US has an incredible trove of multitrillion-dollar assets that could be sold or privatized to raise funds. Obvious examples include the 640 million acres of land in the United States owned by the federal government, the mortgage portfolios within Fannie Mae and Freddie Mac, or student loans, etc. Or Congress could use its taxing authority to raise revenue to make debt-service payments. While these are not appealing options, they are levers that could be pulled if needed.
What About Federal Deficits?
Deficits and debt fit hand-in-glove; they are related, but different. Fiscal deficits—budget shortfalls—are a primary cause of increased debt. Again, the reason for the recent dramatic increase in fiscal deficits was the aforementioned pandemic response (See slide 6). But this isn’t just a US problem, all of the key economies have pushed their fiscal deficits higher by roughly similar relative amounts (See slide 7). Thus, the US’s fiscal deficit in relative terms has remained in-step with peers in the near term.
Moreover, these deficits are likely temporary (See slide 6). We are not suggesting that deficits don’t matter; however, there will be plenty of time to address the budget deficit in the coming years. Specifically, we believe that deficits need to be balanced over an entire economic cycle, but there are legitimate reasons to temporarily overshoot, such as Great Financial Crisis, and the COVID-19 pandemic.
Rising interest rates, which push up the interest expense to service the debt, are another cause for fiscal deficits. But, there are few reasons to see that situation changing anytime soon, especially given historically low interest rates globally at present, including negative interest rates in several key regions such as Europe and Japan.
Doesn’t Huge Federal Deficits and the Federal Reserve “Printing Money” Cause Inflation?
Nobel laureate Milton Friedman rightly warned that “inflation is always and everywhere a monetary phenomenon,” and was caused by “too much money chasing too few goods.”
Indeed, there has been a dramatic increase in the size of the Federal Reserve’s balance sheet (See slide 4, left chart) in the past decade, first to address the Great Financial Crisis and now to help markets function properly amidst the COVID-19 pandemic. This has greatly expanded the money supply.
Yet, despite the increase in the money supply, inflation has consistently been markedly lower for the past 20 years. The Federal Reserve’s preferred inflation metric—the annual change in PCE prices—has averaged just 1.5% in the past decade and 1.8% since 1999. The lack of inflation over this span coincides with a sharp decline in the velocity of money, which is the number of times a US dollar is spent to buy goods or services. This is due to individuals and businesses holding more cash, which we believe is warranted due to uncertainty.
Furthermore, that excess cash is held with banks, which have historically had a strong incentive to put those reserves to work by lending it out. But, with individuals and businesses already flush with cash, there has been less demand for new loans. Thus, there is less “chasing” of goods, as Dr. Friedman put it, and lower inflation generally.
While it might be politically unpalatable, Congress and the White House could reprioritize paying down the national debt or, at the very least, not adding to it. Again, unlike other countries—such as the recent examples of Argentina, Greece and Italy—the US can manage its debt load. While we believe debt levels are not a concern in the near-term, the topic does merit attention over the longer-term. Additionally, inflation is less of an issue in turbulent times, especially as individuals and businesses are holding more cash.