When the fiscal year ends on September 30, our national debt will be about $18.5 trillion. If we have 3% growth this year (considered to be a minimal goal of good growth), the Gross Domestic Product (GDP) in the U.S. will be about $17.8 T. This means that our national debt will be equal to approximately 104% of GDP. The percentage of U.S. debt to its GDP has only been higher during WWII – to pay for that war.
Among developed countries, only three have a higher percentage of debt to GDP: Japan, which has had a stagnant economy for more than 20 years; Greece, which has the worst and most dysfunctional economy in Europe; and Italy, which has seen its GDP shrink since 2008.
U.S. debt as a percentage of GDP has risen from 32.5% in 1980, and 55.7% in 2000. We’re headed in the wrong direction. Many economists believe this high level of debt will eventually have a significant negative impact on our economy, and that we may be reaching the tipping point for real financial trouble in a few years.
Some people say deficits and the national debt don’t matter. Many in this group maintain that because the U.S. has the strongest economy and military, we can run up the national debt ad infinitum. Their thinking is that as long as other countries are willing to buy our debt, we can continue down this path.
It’s a nice theory, but it’s not a new or wise one. Many smart people in the United Kingdom had the same theory near the end of the nineteenth century. Unfortunately for them, after two world wars, the Depression, and the end of colonialism, England went from being omnipotent to almost impotent. The U.K. went from having the world’s strongest economy (by far) and a substantial creditor nation, to being a large debtor nation.
Throughout the nineteenth century, the U.K. was unquestionably the world’s superpower, both economically and militarily. But early in the twentieth century, at the same time England was losing its way financially, America’s economy was growing and soon surpassed the U.K. By WWII, America had become the world’s economic superpower, and London could no longer call its own tune as it became dependent and largely subservient to the U.S.
Since then, America has been the country most able to dictate financial terms to the rest of the world. But that’s changing. With the emergence of China and its rapidly growing economy, the U.S. may soon face a situation similar to the one faced by the U.K. in the first half of the twentieth century.
China now has the second largest economy (GDP) in the world, and it is projected to overtake the U.S. as the largest within 5-7 years. By 2030, China’s GDP is projected to be twice the size of America. China is also the largest holder of U.S. Treasury Bonds (our debt). As China’s economy has gotten stronger, and its dollar stockpile has grown, Beijing has started to flex its economic muscle and become more resistant to U.S. financial leadership.
This scenario could lead to some difficult situations for America in the future. Fast forward 5-15 years. If China stops buying our bonds, or worse, starts selling them, it could make other buyers of our debt scarce. This might force the Federal Reserve to raise interest rates to attract buyers. Higher rates would make our interest payments an even larger portion of an already stretched U.S. budget.
Since the U.S. (or any country) cannot control global bond markets, this is a situation that could rapidly spiral out of control for America. If this happens, we will only have bad options to choose from, such as: Drastic cuts in both mandatory and discretionary spending; raising taxes substantially – not easy to do and counter-productive in a bad economy; or trying to run enormous annual deficits – if we can get enough takers on our debt instruments.
Worst case, we may need to ask China for a bailout. If so, the price will be steep and there will be strings attached.
When the U.K. began to lose its status as the world’s superpower, it didn’t happen overnight. And Britain did its best to hang on to the power that comes with being the global economic giant. But as America’s economy surpassed England’s, it was not surprising for the U.S. to wrest control over international financial systems from the Brits. Fortunately for the U.K., America was a very strong ally, and helped make the transition a smooth one.
If the day comes when China can begin to dictate financial terms to the U.S., we may not be so fortunate. While China is not our enemy, they’re not an ally. When China becomes the world’s economic superpower, no one can predict if it will be benign or malevolent.
If the U.S. is in a weak financial position, and drastic spending cuts include large reductions in defense spending, we may have to agree to unpleasant demands from Beijing. Like U.S. withdrawal from its military bases in Asia, and other unpalatable choices.
There are many reasons why deficits matter and why we should be alarmed by our growing national debt. But first and foremost, it should be considered a national security threat.
It doesn’t have to be this way. There is still time to make the adjustments necessary to eliminate deficits and begin to reduce the national debt. But our national debt is a time-bomb, and the clock is ticking.
In next week’s blog, I plan to write more about China’s financial systems and our national debt – I think you will find some of the details interesting. This is also the second of a series of blogs that I plan to write about the economy and U.S. fiscal policy. I’m asking my readers to follow along as I first describe the current situation, and then begin to lay out what I think could be an effective bi-partisan comprehensive plan.
Links to related blogs:
Budget concerns: http://www.commonsensecentrist.com/the-federal-budget-were-getting-boxed-in/
Economic growth: http://www.commonsensecentrist.com/growing-the-economy-the-road-ahead/
Fiscal policy: http://www.commonsensecentrist.com/leadership-not-misleadership/
Deficit reduction: http://www.commonsensecentrist.com/passing-the-buck-really-big-bucks-2/