I wanted to do a bit of a deeper dive today on the topic of the national debt— and answer a basic question: is the debt a terminal problem? Or is it still fixable?
I actually had a bit of a debate on the topic with my friend and partner Peter Schiff last week. Peter thinks it’s terminal… and that there’s no way it could be paid down.
Based on the math, I disagree. There are a lot of things that have to go right, and very little that can go wrong. But at the moment, it is still possible to improve America’s gargantuan national debt challenge.
The first and most important thing to understand when discussing national debt is that the really important number to consider is the Debt-to-GDP ratio… not the actual debt itself.
Today the national debt is nearly $35.3 trillion, or roughly 125% of GDP. In other words, the national debt is 25% larger than the entire size of the US economy.
Typically even a debt-to-GDP ratio of 60% is considered high. 80% is dangerously high. But developed countries in Europe, North America, and especially Japan get away with higher levels of debt because their economies are more advanced and productive.
For most of its history, the US had a very low national debt— with periodic exceptions like World War II. Even during the 1980s, the debt-to-GDP ratio hovered at around 30%… and even that level raised some eyebrows.
Older readers may remember businessman Ross Perot running for President in 1992, and a large part of his campaign was bringing down the national debt (then roughly 60% of GDP).
But by the end of the 90s, with the economy booming and the government actually running a small budget surplus, America’s debt-to-GDP ratio had dropped to around 50%.
It didn’t last.
The War on Terror was extremely expensive, and by the end of George W. Bush’s terms, debt-to-GDP had spiked back to 65%.
The debt then quickly reached 100% of GDP during Barack Obama’s first term, much of that due to bailouts and benefits paid in the aftermath of the 2008-2009 Global Financial Crisis.
The debt-to-GDP ratio hovered at around 100% during Obama’s second term, and during Trump’s first term… until the pandemic hit in 2020. The resulting economic shutdowns and insane government spending pushed the ratio to an all-time high of 133% of GDP.
Although debt-to-GDP has slightly decreased as some COVID spending programs have finally been discontinued, the ratio now stands at 122%… and it’s rising.
Ultimately to solve its debt problem, the US government must first stop making it worse. That’s the priority. So this means ensuring that debt-to-GDP doesn’t rise beyond 122%.
So that’s really the question: is it possible to stop the increase in debt-to-GDP?
Yes. But it will come at a significant cost… with plenty of challenges and uncertainties.
So let’s do some basic arithmetic. In order for the debt-to-GDP ratio to remain the same, it means that both the national debt and US economy must grow at the same rate.
In other words, if the US economy grows by 5%, then the national debt can also grow by 5%, and the ratio will stay the same.
It’s not unusual for the US economy to grow by 5% in a single year.
Bear in mind that this “nominal” GDP growth includes the impact of inflation. So if inflation is 4% in a single year, and real economic productivity growth is just 1%, then overall GDP growth will be 5% for that year, i.e. 4% + 1%.
On average in the three decades from 1989 through 2019 (i.e. pre-Covid), average GDP growth in the US was right around 5%— which, again, includes the effects of inflation. So this is a reasonable assumption.
Simultaneously, a 5% increase in the national debt (which is roughly equivalent to that year’s annual budget deficit) is a substantial number. Again, the national debt is $35+ trillion. 5% of that is a whopping $1.75 trillion.
In other words, as long as the size of the US economy grows by 5% (whether through inflation, or actual productivity growth), then the annual budget deficit could be $1.75 trillion… and the debt-to-GDP ratio would not increase.
Obviously this is an absurd sum of money. A $1.75 trillion deficit is ridiculously large. So you’d think that the federal government would be able to run its operations with a $1.75 trillion deficit.
Unfortunately that’s not the case; this year they expect to be over-budget by nearly $2 trillion.
So right off the top, they’re going to have to shave around $250 billion from the budget this year in order to achieve a deficit of “only” $1.75 trillion.
Where will they cut that money? Well remember, there are three main categories of government spending:
- Interest on the debt: This cannot be cut without a US government default, which would undoubtedly spark an immense global financial crisis.
- Mandatory spending such as Social Security and Medicare: No politician has the courage to touch mandatory spending.
- Discretionary spending: This is the only realistic place where spending cuts can be made.
However, cutting discretionary spending is no small task.
For fiscal year 2025, the President’s budget is set at $1.8 trillion. Roughly $800 billion of that is military spending… and, like Social Security, few politicians have the willingness to cut Defense.
So that leaves $1 trillion for what’s called “Non-Defense Discretionary Spending”. Think NASA, the Department of Education, National Parks, etc. They’ll have to trim these budgets by 25% in order to save $250 billion and achieve a $1.75 trillion budget deficit for the year.
And remember, even making those cuts would only freeze the debt-to-GDP ratio at its current level—not reduce it.
To maintain this freeze, similar austerity measures would need to be enforced year after year, leaving no room for unforeseen expenses, emergencies, or economic downturns.
Now, the irony is that executing on this idea, i.e. slashing a significant portion of the federal government— would also liberate the economy from excessive regulation. Fewer government bureaucrats means a more productive private sector… and that’s precisely what’s needed to generate economic growth.
This, coupled with technological advancements like AI could boost productivity and real GDP growth, and could even reduce inflation. Eventually GDP could be growing faster than the national debt, and the overall ratio would fall back to a safer level.
This is still, right now, a possible outcome for the US. I’m reminded of that wonderful line from Dumb and Dumber, “So you’re telling me there’s a chance!” Yes, I am. There is a chance.
But it will require difficult decisions, politicians who understand the problem (and are willing to solve it). And a fair amount of luck that no major wars, emergencies, or new pandemics occur.
This solution also means there is no money to bail out Social Security. When the trust funds run out of money in less than ten years, retirees would take an immediate 20-30% cut in benefits. That’s year one, and it would likely only grow worse from there.
Yet this is still a far better outcome than the alternative.
If the US government does nothing— and continues to overspend by trillions of dollars each year, debt levels will likely rise far more quickly than the US economy can grow. And most likely within a few years there will finally be a point of no return where it will be virtually impossible to pay down the debt and salvage the government’s finances.
Bottom line, America cannot afford another four years of ignoring this problem, no matter how much “joy” the politicians intend to bring.
So, yes, while the debt problem is still fixable, I wouldn’t hold my breath.
This is a key reason why we emphasize owning real assets, i.e. the most critical resources in the world, like productive technology, key minerals, energy, and food.
Unlike fiat currency, these assets can’t be conjured out of thin air by central banks or politicians. And they historically perform very well in times like these where debt and inflation appear to be major challenges ahead.
