- Dan Connors
Living on borrowed time? How debt could affect our future.
The headlines are scary and relentless. We are in debt and getting more so. All three levels of debt- government, corporate, and personal are on the rise. The national debt recently passed a record 23 Trillion dollars, which is higher than the size of the entire economy. That translates to about $66,000 of debt for every man, woman and child in the US, most of it borrowed in the past 20 years. Even worse, the annual deficit is expected to top $1 trillion just for 2020, a number unheard of in peacetime with a healthy economy.
If the deficit is $1 trillion now, should we enter a war or a recession, you can be sure that it will go up significantly, perhaps doubling or more. The main drags on the deficit are the big three- Social Security, Medicare, and Defense spending. The aging of America means that more people are claiming Social Security and Medicare benefits than ever before. The US Defense budget, largest in the world, is immune from political and fiscal pressures and continues to grow no matter who controls Washington. In addition, as the national debt goes up, the interest payments on the national debt will continue to rise, taking up more and more of the budget. If meaningful cuts were to be made, healthcare, retirement, and defense would be the ones most hit.
In order to close the deficit, the GAO estimates that either government spending would have to drop by 25% or taxes would have to increase by 37%, both of which are unlikely and unappealing alternatives. Politicians now pay lip service to the deficit, but neither party seems to have the stomach for substantial changes in taxation or spending. In fact, the recent tax cuts of 2018 have only seemed to make the problems worse. Some economists say that deficits aren't necessarily a bad thing, as long as you can keep making the payments and seeing real benefits that help the country.
Corporations have been using deficit financing throughout the last decade as the economy recovers. Corporate debt is estimated at $15.5 trillion dollars, a record high and nearly 75% of the entire economy. Many corporations are flush with cash and don't need to borrow, but tax laws and shareholder needs make borrowing attractive. As long as corporations can continue to make their monthly payments, it makes good sense for them and the shareholders are happy.
Personal borrowing, also known as US consumer debt, is also at a record level of $14 trillion. The biggest portion of that is homeowner debt, but a growing portion is student loan debt and car loans. Again, as long as people make their monthly payments, the benefits of having cash for education, transportation, and housing outweighs the risks that things could go wrong.
So what could go wrong? There are two things that could turn this system upside down- rising interest rates or a recession. In a recession, business activity slows and people get laid off or make less money. Typically loans can get defaulted on, and bankruptcy filings can be a result. Unpaid loans have a ripple effect all over the economy, and they were the biggest cause of the 2008 recession. Loan payments take priority over almost all other spending, and corporations have to tighten their belts more when loan payments are higher. Governments tend to suffer in recessions too, as tax revenues slow down, and a vicious cycle emerges as lower government and corporate spending leads to bigger deficits and more layoffs.
The other unknown is interest rates. This is the percentage of a loan that you have to pay back above the value of the money borrowed, and it has been at historic lows for nearly a decade. In the 1980's interests rates were raised as high as 15% to combat inflation, and today they sit around 2% for a 10-year federal bond. This translates to mortgage rates, car loan rates and student loan rates as well, which are all lower than they have been historically. Low interest rates are what's been keeping our economy going the past few years. Why would we ever think of raising them?
Governments set some interest rates, but they don't control them all. Interest on US bonds and Corporate bonds are set by the marketplace, and if there were a global recession, it could become harder to sell large quantities of securities at 2%. Rates would have to rise until the market equalizes. The other wild card is banks, which are privately owned. Banks have to make a profit to exist, and their interest rates are somewhat influenced by the government but also dictated by the quality of the loans they make. If people stop paying their mortgage and car payments, bank interest rates may have to rise to make up the difference.
If talking about this makes you nervous, I'm there with you. The numbers are astronomical and smarter people than us have done the math and say it works. )They were saying that back in 2008, too). If you've ever listened to Suzie Orman or Dave Ramsey, they are big on paying down your debts as much as possible. At least on the personal level. Borrowing your way to wealth is extremely risky.
The bottom line is that you should never borrow without having two or three plans to pay it back. Those extending all these loans need to account for the unexpected, because the world is uncertain. Getting in over your head, or even worse passing debt onto your children, is not sustainable. We all can't file bankruptcy, because the economy would cease to exist. It will be interesting to see what happens in the 20's, but nothing is likely to change until one or both of the disrupters discussed above shakes things up. 2020 is an election year, and it will be interesting to see how the politicians will address this. Until then,keep making those payments and watch those rates.