How Much Debt Is Too Much? Next Question, Please
On economic policy, the early signs from the new Biden administration are encouraging. President Biden has nominated a top-notch team of economic policy advisers, including former Federal Reserve Chair, Janet Yellen, as Treasury Secretary. He has proposed an ambitious $1.9 trillion economic recovery plan, aiming to “go big” with aid for state and local governments, more direct aid for households and firms, expanded unemployment insurance, and a range of anti-poverty initiatives. In stark contrast to the 2008 crisis, the broad consensus among analysts is that this is the right way forward, and that concerns about debt and deficits should be set aside until the pandemic is under control and the economic recovery is well underway.
Nonetheless, the usual “deficit hawks” have predictably re-emerged with “concerns” about whether we can afford all of this debt and spending. One must use quotes, of course, since most of these “hawks” also supported trillions in deficit-financed tax cuts during the Trump and Bush administrations, only to suddenly rediscover fiscal rectitude now that Democrats are in charge. This week, Senator John Thune (R – SD), asked in Janet Yellen’s confirmation hearing, “How much debt is too much?” and fretted about the “massive amount of debt that we continue to rack up.” On Tuesday, the Wall Street Journal ran a sensationalist front page headline about “Janet Yellen’s Debt Burden: $21.6 Trillion and Growing.” This followed its Sunday feature article on Yellen and Biden’s proposed policies that echoed Thune’s question (“How Much Is Too Much”) in the headline and began by stating that the US debt level (100.1% of GDP), now puts us “in company with economies including Greece, Italy & Japan."
This is simply not the case. Italy’s debt-to-GDP ratio is 158%. Greece’s is 207%. Japan’s is 250%. The US is not remotely in the company of these countries, and it hasn’t been for decades.
American politicians and journalists frequently note that the US is the world’s richest and most powerful country. And yet, time and again, the same politicians and journalists behave as if the world’s richest and most powerful country is a cash-strapped household or a smaller, less financially important country that borrows in foreign currency at higher interest rates. This leads to serious misconceptions about the degree to which our debt level poses a fiscal constraint on the US government. Indeed, beyond its vastly lower level of debt than Italy, Greece, or Japan, the reality is that the United States - even at 100% of debt to GDP - enjoys a degree of fiscal policy autonomy that is unparalleled by any of these countries, or by any other country in the world.
Why is this the case? First, the US borrows in its own currency and has a floating exchange rate. In contrast, Eurozone countries, as members of Economic and Monetary Union (EMU), cannot unilaterally print Euros, adjust interest rates, or allow their currency to depreciate. As a result, the US enjoys far more monetary and fiscal policy autonomy than Eurozone members like Italy and Greece. A key implication of this is that the repeated warnings by some deficit hawks of the imminent risk of “sudden stop” crises, hyperinflation, and defaults - as occurred in the 1980s and 1990s in Latin America and East Asia in developing countries with fixed exchange rates (& which borrowed in foreign currency) – are simply not relevant comparisons for the US. Indeed, neither are the comparisons to the problems of Greece or Italy in the last decade. These countries effectively borrow in foreign currency and simply do not enjoy the same level of macroeconomic policy autonomy of the US. And yet, even so, they have been able to sustain debt-to-GDP levels far higher than 100%. Indeed, international investors are pleading nearly as loudly for Greece and Italy to borrow as they are for the US.
Second, unlike Japan, the US issues the world’s dominant global reserve currency. It does so in an era in which international capital flows have increased thirty-fold, from about $1 trillion in 1980 to about $30 trillion today.
Consequently, demand for US dollars is at an unprecedented high. This is due in part, as David Beckworth notes, to the Federal Reserve’s policy initiatives in response to both the Global Financial Crisis and the COVID crisis, including expanded swap lines to foreign central banks and new facilities for those banks to temporarily trade their US treasury securities for dollars. Along with the massive increase in cross-border capital flows, these Fed policies have increased global demand for dollars and deepened the dollar’s role as the dominant global reserve currency. Thus, despite frequent predictions of the dollar’s imminent demise, US dollar hegemony remains unmatched and unthreatened. There is simply no viable alternative in sight, and there is no sign there will be for decades. This persistent “exorbitant privilege” creates more fiscal policy room for the US government to borrow and run deficits without increasing the risk of future inflation. No other country in the world – not even other reserve currency issuers like Japan, Canada, Switzerland, or the United Kingdom – enjoys a comparable degree of fiscal policy autonomy.
This raises important questions for which supposed “deficit hawks” do not seem to have answers: How is it that Japan has been able to borrow at interest rates lower than the US and sustain debt levels 1.5-2.5 times ours since the 1990s, without experiencing a sudden stop, default, or massive inflation? Why, then, should the US worry about these problems at 100% of debt to GDP? Or even at 200% or more? Why is now the time for deficit and debt reduction? Why, since so many "deficit hawks" also rush to extol the merits of free markets, should we ignore the markets' signals of negative real interest rates on US Treasuries across the entire yield curve?
To repeat: there is 30 times the amount of money moving around in the global financial system as there was 40 years ago. An overwhelming share of that capital is denominated in dollars, and a decade of crises has only reinforced investors’ demand for holding our debt and currency. Interests rates have secularly declined for 40 years; in fact, they have done so for five centuries. Debt service levels are at historic lows. In order to believe that the US now faces serious debt constraints, one must explain how, when, and why these realities and trends will change. And one must offer some coherent explanation for why a country that issues the world’s reserve currency, in a time of unprecedented global capital flows, with the full monetary autonomy provided by a floating exchange rate, faces a hard budget constraint at 100% debt-to-GDP, when countries like Italy and Japan do not. One can certainly theorize scenarios of future increases in inflation, but frankly, the four decades since the oil and Volcker shocks suggest that the high levels of the late 1970s and early 1980s were an anomaly, rather than the normal reversion point. And one should recall that, even at the peak of high inflation in 1980 (13.5%), the US faced absolutely no difficulty issuing sovereign debt or running large fiscal deficits.
In this context, questions about what we can afford, or how much debt is too much, are not merely premature; they are functionally irrelevant. One does not need to be an adherent of Modern Monetary Theory or a denialist of the long history of sovereign debt crises and defaults to believe this. One simply needs to look to mainstream open-economy macroeconomics of countries that borrow in their own (reserve) currencies, enjoy monetary policy autonomy via floating exchange rates, and issue local currency debt in a time of unsurpassed global finance.
This, of course, is not to say that we should abandon responsible fiscal policy, or that the future may eventually be different. It’s merely to point out that the actual fiscal constraint for the US is not even yet visible on the horizon. The Congressional Budget Office forecasts US debt to GDP to reach 195% by 2050. This projection rests on a series of assumptions that may or may not materialize, including completely flat tax revenue until 2050, an increase in the average nominal interest rate on federal debt to 4.4% by 2050, and a projected increase in net interest outlays as a share of GDP from current levels (less than 2%) to more than 8% by 2050. Perhaps these things will occur, and US debt-to-GDP will double along these lines. But it’s equally – if not more likely – given the trends in interest rates, capital flows, growth, and inflation over the last 40 years, that US debt will stabilize or decline at far lower levels.
Still, let’s assume for the moment that the CBO projections are accurate. In that case, in 30 years, US debt will reach 195% of GDP. In other words, there is some possibility that the US debt level, three decades from now, will be less than that of Greece now and more than 50% of GDP below the level that Japan has sustained, with absolutely no difficulty, for the last decade. If these countries can sustain debt levels 50-150% higher than our current levels, then the question of whether we can do so has already been answered. Indeed, it does not even need to be asked.
This is exactly why front-page discussion of debt sustainability in the media now is so troubling. We have been here before, with tragic results. In 2010-11, print and television media shifted drastically from covering unemployment to covering debt and deficits, fueling premature monetary tightening and fiscal austerity, and turning a serious financial crisis into a needless Lost Decade. Premature austerity on the grounds that we couldn’t afford things at a debt-to-GDP ratio of 90% was terrible policy in 2010-17. In the current context, it’s sheer madness.
There is surely a serious discussion to be had about the economic & political tradeoffs of debt and deficits. Reasonable people can and will disagree about how, whether, and when the US should invest more in infrastructure, scientific research, higher education, health care, military equipment, or anti-poverty programs, and whether we should finance these investments through taxes, debt, or some combination of the two. We should certainly have these discussions. But we need to do so in the context of being honest about the essentially nonexistent fiscal constraints the US faces today, given international financial and monetary realities and America's unparalleled dominance in the global financial system.
Asking questions on the front pages about debt sustainability distracts from these debates. Instead, it provides oxygen to the “deficit hawks” and fuels the persistent, incorrect belief that the government is like a household, in which responsible fiscal policy always requires balanced budgets and debt reduction. As Paul Krugman, Simon Wren-Lewis, and others have noted, this "household analogy" is a zombie idea that never dies, and it has affected politicians on both sides of the aisle. It leads, over and over, to faulty analogies with Greece, Italy, Venezuela, and other cases that bear absolutely no relation to the financial situation in which the US finds itself today.
As a country, we can literally afford any and all of the things that we want. The question is whether we really want them, and how the cost of paying for them will be distributed. These are political questions about desirability and distribution, rather than economic questions about feasibility. Whether we can pay for all of the things is not a question we should even waste our time asking. And it is a question the media should stop promoting and taking seriously in its coverage of economic policy debates in the US, today and going forward.
“How Much Debt Is Too Much?”
Next question, please.