By Mike Gold, a retired entrepreneur "living the dream in the Pacific Northwest."
On Tuesday, May 12, 2020, Nancy Pelosi introduced legislation suggesting that the U.S. Government spend upwards of $3 trillion in a third round of public spending to support our sagging economy. (By the way, this will never happen as a good chunk of these suggested funds would be to pay those states in financial trouble – for mostly way too generous pension obligations.) Consider it DOA in the Senate.
Assuming some amount of money not dissimilar to this amount is actually spent this year, that would bring our deficit spending to more than $4 trillion for the year, raising our national debt to approximately $25 trillion. These numbers are so high, with so many zeros after them that it is difficult to comprehend just exactly how much that is.
If we use our 330 million population, that is roughly $83,000 in debt for every man woman and child in the country. Now it turns out the per capita gross domestic product for our country is a quite high $55,000 or so. That’s $55k in production of goods and services for every resident of the U.S. But even then, the amount of our national debt is much higher, per capita, than the GDP.
Numbers of this scale raise some interesting questions. My first question is how on earth could our government run up such a staggering debt? The answer is simple. Whenever there is uncertainty in the world (and one could argue our current situation is about as “unstable” and “uncertain” as it could possibly be), as the world’s largest economy any investible assets owned by anyone anywhere in the world looks for a safe haven for those assets.
One could just bury it in the backyard, or put it under one’s mattress. But then those assets would earn absolutely nothing. And if inflation (which is expected to accelerate as all this world’s debt starts to sink in) is even as small as 4%, those un-invested funds would be worth about half in 15 years. So most people would want to invest those assets in something that would yield something. Still today, that “safe haven” is the U.S.
Now deficit spending of that magnitude is by definition going to cause inflation. So that exacerbates the flow of money into the U.S. even further. Economic pressure (simply supply and demand actually) says that if there is a tremendous amount of money seeking investment in U.S. financial instruments two things are going to happen.
On the fixed income side that will raise the street price of the bond, lowering its return rate. On the equity side, it will tend to “bid up” the buying price of shares in companies (It won’t keep going up, as the investors are expecting a reasonable return – and therefore profits would have to keep pace – which is not guaranteed).
The deficit spending of $4 trillion is accomplished by the treasury just “printing” money. (In fact, it doesn’t actually print bills, rather it is just an “electronic book entry” done by the treasury – simply saying that these additional dollars have been “put” into the economy.)
As long as these conditions persist, the “cost” of our government supporting this debt is modest. Under one percent per year. So at $25 trillion, the servicing of this debt costs the government approximately $300 billion per year. This is a sustainable amount of debt “cost.”
But look out if this “cost” should rise to, say, three percent. All of a sudden, we have a near $1 trillion annual cost to service this debt. With a typical annual US Government budget of approximately $4 trillion this means debt service rises to 25% of the budget. Ouch!
At its most simple level, this is fairly easy to understand. There are some fairly complex financial transactions going on that make it more complex, but this is a fairly simple way to understand it. One example is how does the Federal Reserve actually get this “newly printed” money into circulation.
One way is called quantitative easing. The Federal Reserve actually purchases Treasury Securities. Yes, this is simply moving money from one pocket to the other. But the net result is that money then goes into the banking system where it is used as collateral to “loan out” money to businesses.
One overlooked item in this description is that this makes no provision for actually paying this debt off. When a financial instrument “matures,” it is simply paid off with the issuing of a new instrument. Yes, this does sound a bit like a Ponzi scheme. But as long as this “perpetual motion” machine keeps grinding along, we should be okay.
As I’ve often said, “We have the best house in a bad neighborhood.”