The Debt Bomb Ticking Toward 2033

Is America's national debt a slow-moving crisis hiding in plain sight? In this episode of Through the Noise, Duke finance professor Campbell Harvey breaks down why the U.S. debt is far larger than headlines suggest - closer to $39 trillion once Social Security obligations are counted - and why politicians have little incentive to act before 2033, when the Social Security Trust runs dry. Harvey unpacks Ferguson's Law, the Triffin dilemma, and the alarming fact that 20% of federal tax revenue now goes just to servicing interest on the Federal debt. He weighs the unattractive fixes: raising taxes, inflating the debt away, cutting costs, against the one genuinely promising path forward - productivity-driven growth. 

Transcript

SPEAKER_01 0:00

Thanks again for uh joining us for a new episode of Cam Harvey's Through the Noise. Um, Cam, when I was growing up and until now, one of the most consistent complaints that I hear from all political parties, anyone living in the United States, is the debt is too large. It was too large when I was a child in the 80s, it was too large when I was in college in the 90s, and it's too large now. So tell me a little bit more about this. Is how big of a risk is the debt?

SPEAKER_00 0:31

I believe the debt is a significant risk. Um, and this is uh especially the case when you've got uh a so-called structural deficit. So structural deficit is uh a deficit, even if you ignore the interest being paid on the debt, it means there's a structural problem. So, in the scenario where all the debt is paid off, um, we still uh would be running uh a deficit. So it is significant, and uh and people talk about the debt to GDP being approximately 100% in the US. And we need to be careful here uh because we don't want to compare apples and oranges. So think of the debt as a stock and the GDP is more of a flow. It's like income. And if we look at our personal situations, it might be, and and many uh many people have this situation, that they have a mortgage or mortgage debt that is greater than their income. So uh so we need to be careful here, the but there's no double standard uh in terms of accounting, but nevertheless, uh when we're talking uh a debt to GDP ratio that is so high, this uh creates uh risk. We've got a fiscal um deficit. We also have the current account deficit. And the US um is in a unique situation in that approximately half of the debt is owned by foreigners. Um the Triffin uh dilemma is is very interesting uh to me, and it has to do with the current account or think of it as the trade uh deficit. So a reserve currency is really good to run uh a deficit because it means there's lots of the reserve currency floating around for transactions. But if you continue to run this deficit, then the amount of debt, the amount of leverage that the US takes gets too large. And then people are thinking, well, this reserve currency is too risky. So there is a balancing act here.

SPEAKER_01 2:59

But help me understand a little bit more. So you talked a lot about deficits, but that presumes that there's also something like a surplus could happen. Um when was the last time that we could say that the U.S. had a surplus, just so we can uh orient ourselves in this?

SPEAKER_00 3:13

Yeah, this is in the late 1990s. And I was at a presentation in January at the uh American Economic Association meetings, and Jim Peterba, the president of the National Bureau of Economic Research, made uh just a great uh talk. And he showed um a page from, I think it was the 1998 uh Congressional Budget Office projection of the path of the US uh debt. And uh this was a time where there were a few years of surpluses, and they were extrapolating out into the future to the time where the debt would be zero. And there was an active debate in the late 1990s as to well, what do we do when the debt is zero and we're running surpluses? That means there's not going to be as many treasury bills or bonds out there. So, how do we how do we plan to use the surplus? Should we be buying stocks or something else? So that obviously did not come true. Uh that we've been mired in uh continuous deficits since then, and the size of the debt uh has uh exploded. Uh and and indeed, uh it is shocking to me that 20% of the tax revenue that comes to the government is used to pay the interest on the debt.

SPEAKER_01 4:52

Now let me let me get so we were projecting to go to zero, but from what I was reading, it looks like we're somewhere around what, 39 trillion? Is that uh is that a real number, or what is the real debt in your sense?

SPEAKER_00 5:03

Yeah, so it is uh confusing because um the GDP is approximately 31 trillion and people talk about uh 100% debt to GDPs. Well, that that implies 31 trillion of debt. But if you look at the national debt clock, it just went uh to 39 trillion. So this has to do with the way that the debt uh is counted. And uh and and the lower number is the debt held by the public. So what it does not count is intergovernmental uh debt. So let me just pause uh on this. And the main intergovernment uh debt is the Social Security Trust. Okay, and the idea is that, well, it's kind of left pocket, right pocket, and it's uh and shouldn't be uh counted as debt, even though um it seems like it is real debt. In contrast, the debt that's held uh by the Federal Reserve in this balance sheet that is counted as public debt. So the Federal Reserve is independent and the debt that they hold is counted within the$30 or$31 trillion debt. And the idea is that the Fed might unwind its balance sheet so to draw down from the$6 trillion uh dollars, and then when they actually uh go and and and sell that debt, then it's just held by the public. Okay. But the problem is the same logic applies to the Social Security Trust, which is running a deficit. So to finance Social Security today, they need to liquidate part of that trust. So to me, it makes no sense whatsoever that the Social Security Trust is a real liability of the government and it should be counted, and our debt is not 31 trillion, it is 39 trillion, which is well above our GDP level.

SPEAKER_01 7:22

So you're thinking so you the way that you're defining debt is um obligations which might be hidden, plus our actual debt. Yes. And um it sounds like you're also saying that this is there's largely a political aspect to this, to this debt. And uh and that's that's my experience as a child, is that it's always on the politicians. So if you're seeing this crisis and other people are seeing this crisis, why don't our politicians see this crisis?

SPEAKER_00 7:47

Yeah, so I I really think uh that to deal with the debt, uh often people are talking about increasing taxes, and that is a toxic word for any politician. So I don't think there'll be any action whatsoever until we get close to 2033. And that date is important because that is the date that the Social Security Trust runs out of money. And it's highly predictable, we've known this for the last 10 years, that this is the date. So when the trust runs out of money, there will be an immediate haircut of at least 20% in terms of Social Security payments. That will create uh a political issue. And it's likely that some action will happen close to 2033, probably before, because many people will be impacted by this 20% uh cut. So I see no progress uh uh politically to fix this structural problem until probably 2032.

SPEAKER_01 9:03

So, as we're thinking about this, people who are not in this every day, is there like a heuristic or a some something that we can think of, some sort of measurement that's easy for us to look at um so that we get a sense of how big this problem is?

SPEAKER_00 9:16

There's many uh heuristics, and and and one of them that's in the media all the time is this idea of Ferguson's law. So this is named after the Scottish uh economist Adam Ferguson, uh, who uh who had this idea that any great power that is spending more on interest service to pay the interest on the debt, spending more on that, then national defense will not be a great power for long. And that's exactly the situation that the U.S. is in uh right now. So this is an example of a heuristic, but your question is a deeper question. What is the tipping point? And we don't know. And it's difficult to compare across different countries. All we know is at some point, as that leverage, so when I say leverage, I just mean kind of the the debt divided by a GDP, as it gets uh too large, that increases risk. And when risk increases, that means interest rates also uh increase, which means the service on the debt will increase. So there's this tipping point, uh, and it could uh be uh potentially disastrous.

SPEAKER_01 10:44

So what are the trade-offs? Like what are when when I'm when I'm sitting here today uh and we're looking forward, what are the things that we're gonna have to give up? The downsides of having this this uh debt?

SPEAKER_00 10:54

Yeah, so it's it seems like for most uh most Americans uh this isn't really a big deal. So just spend. Uh interest rates are not double digits or anything like that. The US uh seems to be doing fine. We're really talking about the future. And when you've got a deficit of$1.9 trillion at a time of low unemployment, um reasonably low inflation and record high stock market, that doesn't make any sense. And you would expect a$1.9 trillion deficit, maybe in the depths of a recession. We're not in a recession right now. So so what did what is the implication? Like to me, I think we lose flexibility. So if there was a crisis, and that crisis might be a pandemic, a serious recession, a war, then given the size of the debt, the government does not have the flexibility to take actions. They're constrained because of the position that they're in. And historically, what we used to do is to have a very moderate amount of debt. And then when a crisis occurred, for example, World War II, then the debt explodes, and then we pay it down, and then the next crisis you spend. So we're in a situation now where we've had many years without a crisis, but the debt just keeps on going up and it decreases flexibility.

SPEAKER_01 12:34

So you've described numerous factors that go into why we are where we're here. Some of them are psychological, some of them are political, some of them are mathematical. Um, but it seems like there's a strong argument for us to find a way out of this. Um, so what options do we have available?

SPEAKER_00 12:53

So many of the options are very unattractive. So option one is obvious uh increase the tax rate. And uh social media you see this graphic looking at the tax rates for uh developed countries, and the US is on the low end. And uh it is to me very misleading uh because in some of these countries the tax rate is higher because they provide, for example, health care. And that's not factored in in the US. But this idea of increasing taxes, again, is politically toxic. It's very unattractive, it's negative for economic growth also. So that's a very unattractive uh sort of option. That's option number one. Option number two, uh, as I mentioned, uh about half of the debt is held by foreigners. So one thing you could do is just inflate. So print money to pay off the debt. And that would effectively expropriate uh those that uh hold uh the debt. So it means that the value of the debt would go down uh with that inflation. Uh again, this is unattractive for raising money in the future. It's unattractive because inflation is a tax and it's a regressive tax. So number two, just print the money to pay it off is unattractive. Number three is attractive, and that is to grow. So we've talked about the potential productivity growth that is on the horizon, and it could be very significant. When you grow, when there's a surge in growth, even if the tax rate is identical, the tax revenues increase. So that is by far the most attractive. There are other variants of this. Uh, we tried some cost cutting, uh, and there's very limited um room to do that. There's also asset sales, like sell national parks and stuff like that. These are are fairly unattractive, and they don't fix the structural problem.

SPEAKER_01 15:14

Well, this is this has been very interesting. Um, my big takeaway is that we we do talk about the debt a lot, um, but we don't talk about growth a lot in the same way. We don't talk about it as the the core national uh focus. So thank you for kind of ending that way. I think that's a fascinating way to end this conversation. Good. Great. Thank you.