Tyrannosaurus Debt Chomps Our Future
The venerable Schoolhouse Rock released the Tyrannosaurus Debt video in 1996 warning young Americans about Congress’ profligate spending and the risks posed by a rapidly rising national debt. At the time, the national debt was only $4 trillion. Since 1996, legislators, both Democrats and Republicans, opened the throttle on financial irresponsibility and took the national debt to new heights. The national debt reached $9 trillion in 2007 amid two expensive wars in Iraq and Afghanistan. After using quantitative easing and stimulus spending in response to the global financial crisis the debt hit a record $14.7 trillion in 2011.
During the past decade the economy recovered and the financial situation for many households improved with lower unemployment, record high stock prices and significant real estate appreciation. Did our legislators act prudently and pay off some of this excessive debt so we could prepare for the next crisis? Nope! Like Calvin and Hobbes on a Pixy-stix fueled spending spree, they racked up more debt reaching $22 trillion in 2019. When the COVID-19 virus hit in 2020 many businesses temporarily closed and laid off or fired staff. The Federal Reserve and Congress increased stimulus spending and quantitative easing to help restart the engine of economic growth. A few months later, the debt is now nearing $25 trillion. Expect the stimulus measures to continue in this recession and our debt numbers continue to climb. You can track the national debt here.
Unfortunately, You Owe $200,000
Our current national debt is approaching more than $75,000 per citizen and exceeds $200,000 per taxpayer. If you think of this $200,000 debt like a mortgage at 4%, you would need to make payments of $955 per month for the next 30 years. In addition, the U.S. Census bureau reports that in 2018 the average median household income was $63,179. That means each taxpayer's share of the national debt is more than three times the median household annual income. By racking up such high debt levels our legislators have indebted future generations. Think about that the next time you vote.
Have We Been Here Before?
Some economists will try to downplay this risk by saying we have been here before with similar debt levels after WWII. That is true, but unlike today that high level of debt was relatively short-lived. The country went into a major economic expansion after WWII and responsible spending brought the debt levels down by the 1970s. Unfortunately, Congress shows no sign of being more financial responsible in the near future. Some economists will also say that although our debt is rising, the U.S. economy has also been expanding during these years. This is true, but we can measure this by looking at Gross Domestic Product (GDP), which is all the goods and services produced by the country, and comparing it to the size of the debt. Our debt to GDP ratio has grown from 34% in the 1980s to 58% in 2000 to 116% today. Hence, our debt levels are rising faster than the economy is growing.
Single Biggest Threat to Our National Security
How serious is the threat of our excessive national debt? In February 2018 Director of National Intelligence Dan Coats, while testifying before the Senate Intelligence Committee, said the growing national debt, then $20.6 trillion, is the biggest internal threat to U.S. national security. Similarly, in 2012 former Chairman of the Joint Chiefs of Staff Mike Mullens said the national debt, then $16 trillion, is “the single biggest threat to our national security.” In July 2018 the non partisan Congressional Budget Office (CBO) also warned that unless policy makers act, the rising debt could jeopardize the country's future as the country is less prepared to pay for the next major recession, national disaster, or threat to national security. Our legislators and we as voters were sufficiently warned about the dangers of this debt.
Failed to Prepare for Bad Times During Good Times
In the ten years since the global financial crisis we missed an important opportunity to rebuild the reserves that would help pull us out of future recessions. We failed to prepare for bad times during the good times. As the debt piles up, the cost of servicing it becomes a larger percentage of the annual federal budget. The CBO warns that debt servicing will be the third largest category of the budget after Social Security and Medicare. This debt servicing crowds out our ability to spend on new infrastructure, innovative research, health care, defense, and social services.
What it Means for Your Investments and Retirement
The book Become Loaded for Life offers many strategies for reducing downside risk in investing and for your retirement. Successful investing means navigating recessions like the one caused by the COVID-19 pandemic. Successful planning also requires calculating how our excessive national debt will impact your investments and future retirement. Below are four considerations brought about by our unsustainable national debt levels.
1. Plan for Fewer Services: The best way to get out of debt is to cut spending. As a country we overspent for years and need to tighten spending to curb future deficits. The government needs to bring spending back in line with what it collects in taxes, so our budgets are balanced. This means there will be less money available to pay for social services, financial stimulus, and defense. It may also mean you will likely see lower Social Security Retirement Benefits and Medicare benefits in the the future. Factor this in to your financial planning.
2. Plan for Higher Taxes: The other way to get out of debt is to raise your income level. For the government this means increasing taxes to pay down debt. In the future income taxes and capital gains taxes are all likely to increase, particularly for those who are in the middle class and above. For businesses it means payroll taxes and corporate tax rates will increase. Your retirement plans need to factor in the possibility of higher taxes or that your after-tax income may less than you expected.
3. Plan for Slower Growth: When you reduce government spending and increase taxes it also reduces the amount of money available for private sector investment. Companies become less likely to hire additional staff or take risks with their capital, fearing the returns might be lower. It also means companies are more reluctant to spend on new facilities or technology which would improve productivity. Part of the reason our economy has grown so much since the global financial crisis is because taxes and interest rates were both low which meant profits were higher and the cost of capital was low. As taxes rise and government spending falls, expect lower growth levels than in recent years. That could translate into lower stock returns and lower dividends in your retirement accounts.
4. Loss of Confidence: Investors purchase U.S. government debt because they trust the government to repay this debt with interest. This level of trust also allows the government to offer a low rate of return to borrowers because the perceived risk of default is low. If investor confidence is shaken, they will require higher rates of return to purchase this debt. Above we used the example of $200,000 in debt at 4% over 30 years for a monthly payment of $955. If investors lose confidence they will demand a higher interest rate. If the interest rate on the $200,000 went up to 5%, the monthly payment increases to $1,074. If it went to 7%, the monthly payment jumps to $1,331. Each time the interest rate rises, the more will cost to service the same amount of debt. This will divert more revenue away from other government programs or services to pay debt. Investors lose confidence in a borrower when they think the borrower is over leveraged and can't repaying their debt. The more debt the U.S. government adds, the more likely it will be to lose the confidence of investors.