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How It Works: Federal Debt Sustainability and Deficit Spending Thumbnail

How It Works: Federal Debt Sustainability and Deficit Spending

As a financial planner, I field a lot of questions from our clients - hopes, concerns, curiosities. Some of them come up more frequently than others, so I thought I'd try to help tackle one. Today's topic: how concerned should I be about federal debt sustainability and deficit spending?

Debt never sounds particularly good, but the real question is about how much cause for concern there really is. You know, concerns that if the government continues to spend the way it currently is, that our great-grandchildren are going to somehow be in abject poverty or debtors' prison.

Here's the mathematical argument for the government being able to spend more today and repay it more easily tomorrow.

Start with a Bigger Picture of Time

First of all, you and I operate on a shorter timeframe than the federal government does. We have birth certificates, and one day we'll each have a death certificate. We don't get out of this life alive.

The federal government had as a birth certificate of sorts - the Constitution, the Bill of Rights, things like that. But there's no death certificate. In theory, it continues on ad infinitum. And so, the federal government operates with a much longer time horizon than we do.

We would want to be debt-free at some point. We would want to have our mortgage paid off, our loans paid off, those kinds of things. The federal government doesn't operate that way. The federal government can simply perpetually refinance debt.

How the Federal Government Continuously Refinances

Now, refinance debt at what kind of interest rate? What do those interest payments do to the budget at the time? Those were all very important questions.

But at its root, borrowing money today and repaying it far down the road, 30, 40, 50, or even 60 years down the road is a reasonably smart idea for the federal government so long as those funds are going into improving our way of doing life.

I would personally be far more comfortable with things like a large infrastructure spending bill than I would seeing corporate bailouts to too big to fail organizations and institutions. That doesn't make much sense to me. Anyway, I'll put my soap box away...

Breaking Down Federal Debt Math (aka Deflation)

The way that the government is able to sustain this debt long-term is because, over time, it's cheaper for them to pay it back.

Think about it mathematically this way:

  1. You borrow a trillion dollars today and GDP grows, let's say by 2-1/2 to 3% and inflation is at 2-1/2 to 3%.
  2. Then, the future cost of paying that debt back is dropping at a rate of 5 to 6% per year.

Now, it's important that you get GDP growth, not shrinkage. It's important that you get inflation, not deflation in that process.

It's why, as you've often seen, in really good times OR really bad times, the federal government always does whatever is needed to create inflation. Why?

Because that's the protective barrier for politicians to make sure that even if the GDP isn't growing, at least we're getting inflation. So at least the money that we've borrowed is going to be worth a little less tomorrow, and we'll be a little more able to afford to pay it back tomorrow.

The Debt Game: Long Term Goals, Short Term Needs

Inflation and GDP growth are the two crucial issues in that process. That's why federal government spending, although it is a concern, it's not a systemic threat today, especially in the face of ultra-low interest rates.

We're financing these tens of trillions of dollars worth of debt at the federal level at historically low interest rates.

Now, should interest rates balloon, the interest rate line item in the federal budget becomes a much larger hurdle and creates future pinch on the budget. That's for sure, but we're not there yet. This is the argument for federal government spending being sustainable, at least in the near term. It's not time to panic on that front at this stage.

We here at Vizionary Wealth Management are always here with perspective for the decisions ahead. If you have a question, feel free to call any time. Have a great week.