American national debt and the safety of it's bonds - Vieolo


American national debt and the safety of it's bonds

United States has, for sure, the largest economy in the world with a GDP of more than $18 trillion which is 413% more than the world average. However, over the past few decades, United States have enjoyed a steep leverage economically which has led us here.

A government, just like a company or a person has an income and some expenses. The income is mostly in the form of taxes which it collects for various reasons. Another form of government income is from the nationalized resources which are negligible in the case of the US. And just like any person or corporation, it has a wide range of expenses. Obviously, the number and volume of expenses of a government are not comparable to a person or company but the basic principles remain the same since just like any other being, a government has to watch over the money it spends. 

Imagine a person. Let's call him Bob. Bob has the income of $1,000 and the expenses of $800. So Bob saves $200 a month. But Bob decides to spend $1,200 from the next month. Obviously, his income is $200 short of his income. Gladly, he has managed to save $600 in the past. However, his savings will cover him for only 3 months. From the 4th month, he will need an extra $200 to cover his expenses until the end of the month. So, he turns to his friends and starts borrowing money. 

Theoretically, Bob can live indefinitely by just borrowing more money from others. But, a time will when his friends won’t lend him any money anymore because, obviously, he wouldn’t be able to pay them back. He might turn into a bank to get a loan but that only makes everything worse. Bob, although once a reliable guy, will be bankrupt in no time.

United States government is like Bob, in many ways. United States government, just like any other, spends more than what it earns. However, unlike Bob, US government does not face credibility issues. So it can borrow the shortage of cash which is called “deficit” from the public, institutions or other governments. Credit-worthy governments borrow money by issuing bonds which will give a return to the holder. So, unlike Bob, people or organizations do not lend their money because they like the government. They do that to invest their money which changes a lot of things.

So the government borrows money to cover its deficit and the accumulation of all these borrowings will form the national debt. It is the amount of money that a nation has to pay, eventually.

US national debt was not a big issue till the World War 1 and the recession that followed it. In 1920, when president Harding took the office, the national debt was $25 billion which was reduced to $15 billion by 1930 but again started to increase. The national debt, in the World War 2 reached its peak at 112% of the GDP. 

After the war, things became better and the national debt started to shrink in relation to GDP. However, from the mid-70s, the national debt is rising at a faster speed than before.

In the past 2 decades, the United States, which was already running on a deficit, faced a severe market crash (“.com” boom), started two wars, caused a global financial crisis in 2008, spent a few years in recession, and suffered a few major natural disasters among many other things. These reasons, increased the growth of the national debt a lot, to the point that we are right now.

Unlike Bob, who owes a few hundred bucks to his friends, United States government owes more than $21,152,000,000,000 and I don’t blame you if you have difficulties in counting all the zeros (it is 21 trillion and 151 billion).

This is a very large figure. It is in fact so large, that no one can wrap their head around it. It is 113% of the GDP and without a doubt, the largest figure among any country in the world. But if the number is so large and worrisome, why nobody is running in the streets screaming and nobody is holding signs in the streets with “The end is near” on them?

Well, because, just like Bob, theoretically, US government can go on forever as long as lenders (or investors in this case) are willing to give more money by buying US treasury bonds and this theory has been proved to be true until this moment.

US treasury bonds have been known to be the safest method of investment since the government will never default on its debt. As the result, credit rating institutions used to give an “AAA” rating to the US issued bond which is the highest rating possible.

However, just like Bob’s friends, we have to think about how on earth the United States government is going to pay back its debt before we invest in any US government bond.

This is not a small concern. In 2011, the same credit rating agencies that used to consider US treasury bonds to be the safest method of investment, downgraded their ratings with a negative outlook and to put things in perspective, the national debt was $14 trillion at that time.

The United States government has two way of paying back its debt. The “correct and slow” way or the “quick and dirty” way.

The first way which is the “correct and slow” way of paying back the debts, Bob has to increase his income and/or reduce his expenses and the same is true for the government. It can cut some expenditures and tries to increase its revenue in many ways. 

However, United States government has no practical plan to have a surplus (at this time, even Bob is changing). The Congress just passed a considerable tax cut to the corporations (15 percentage point reduction) without working toward closing any tax loopholes and a change in the income tax of individuals which obviously reduces the revenue of the government. The logic that the lawmakers used to pass this law was based on a forecast that this tax cut can increase the economic growth, compensating for the lost revenue. However, just like any other financial forecast, this forecast can also be wrong and if it turns out to be wrong, US government can face a huge deficit.

On the other hand, It is not doing much about reducing the expenditures either. Although, there have been numerous cuts to the budgets of many social programs in the latest proposal which might sound like a way to save money, the same has been added to the military budget which is by far the largest military budget in the world.

So, in hindsight, US government is neither going to increase its revenue nor reduce its expenditures. This leaves us with the “quick and dirty” way which is issuing more dollars.

Well, unlike Bob who cannot even control his cat, US government controls the dollar can print as many dollars as it wants and since it is going to pay back the investors with the same currency, it shouldn’t be having any issues. This is a sound plan in a Disney movie. However, in real life, by issuing more dollars, the inflation also rises, the problem that Venezuela is currently facing. The higher the inflation, the higher should be the rate of return to lure the investors which result in higher expenses in the future.

So, considering the fact that these two possible solutions are 1. not being used and 2. not practical, will the government pay back its debt? Ever?

With the current plans, the national debt will only increase, making it even harder to pay. As the debt increases, the investors will doubt the government’s ability to honor its commitments (many already have, except Bob!) and once the doubt increases, there will be a reduction in buying new bonds and a sell-off of previously issued bonds which will significantly reduce the government’s ability to cover its deficit.

Then there will be the question of the credibility of the US government in keeping a promise. This credibility is also in question, especially after the withdrawal of the United States from multiple international agreements. So, the government can default on its bonds simply because it was issued by the previous administrations.

So, with the current picture, should we still be investing in US treasury bonds with such a poor return and such a massive debt in the background only because the US government is considered reliable? My opinion is no, we should not.

If the United States was a company with such a debt and a board that changes every 8 years that despises the previous one, we would be considering its bond as the junkiest junk-bond of all times. And I see no reason that we should treat the US government in any different manner. The already issued debts may never be repaid and if it defaults, which it may if the government keeps going down this path, the lenders are the one bearing the losses.



Ramtin

Just a guy with a few visions.

Disclaimer: The opinions and points of views of this user do not represent the point of views of Vieolo.com

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