Can America’s debt get too big to pay?

By Felix Salmon
May 21, 2009

Reader Matthew Kelley writes with a question:

Our national debt is over $11 trillion, it is not unreasonable to think that in my lifetime I will see a quadrillion dollar national debt. Do you think that there is a level of debt at which the United States would pull a ‘latin america’ and just default on the debt?

First, it’s a bit of a stretch to think that in your lifetime the national debt will hit $1 quadrillion. Let’s say you have 50 years to live, and let’s say that, pessimistically, inflation averages 5% a year over that time. US GDP is now about $14 trillion, and if real GDP growth averages 3%, then we’ll have nominal GDP growth of 8% a year for 50 years, which would take us to about $650 billion trillion. So a quadrillion-dollar national debt in 50 years’ time would require a debt-to-GDP ratio of about 150%. It’s all possible, but if you just tweak the numbers a little — say you have 45 years to live and inflation averages 2.5% and real GDP growth is 2.5% — then GDP is just $125 billion trillion when you die, and there’s no way you could have a quadrillion-dollar national debt.

But more to the point, for all the rhetoric from campaigners about countries struggling under their debt burdens, there really isn’t much of a correlation between the level of a country’s debt and the probability that it’s going to default — especially not when that debt is wholly denominated in domestic currency. Countries with low debt-to-GDP ratios can default — just look at Ecuador right now — while countries with very high debt-to-GDP ratios can stay current on that debt indefinitely — Japan is the most obvious example, but there are many more.

If you want to come up with a scenario where a developed country defaults on its debt, you’re most likely to look at a case like Italy, where the debt is denominated in euros and there’s a non-zero chance that the country is forced out of the eurozone; in general, if you want a sovereign default, the best way to get one is to find a country with hard-currency borrowings which then has a massive devaluation. That can’t happen in the US — there’s no currency mismatch between its tax revenues and its liabilities.

Even a doom-monger like John Hussman says that Treasury bonds are “default-free securities” and that the worst-case scenario is not 5-6% inflation for a year or two, but 5-6% inflation for ten years. (Which he calls “a near-doubling of the U.S. price level over the next decade”.) Neither of these things are likely to increase the chances of default — in fact, quite the contrary. Since the US has only a tiny number of inflation-linked bonds, a strong dose of inflation would therefore substantially decrease the real value of the US national debt.

Essentially, the only way to get to a quadrillion-dollar national debt is via inflation — but inflation manages to reduce debt levels all by itself, meaning there’s no need to default any more. So a US default is almost certainly not going to happen.

Update, and irony alert: Obvs wrote “billion” where I meant “trillion”. About 90 minutes after posting this.

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Comments
17 comments so far

Generally, I don’t think that people are asking an economic question about a US Default, but a political one. It reminds me of the social security debate. As near as I can tell, the fear is that taxpayers would refuse to pay the projected amount of taxes at some point, by having their elected representatives change the terms, perhaps drastically.

Such is the case with a US Default. What’s being assumed is that the servicing of the debt would necessitate sacrifices that taxpayers and voters, at some point, decide that they don’t want to pay, or, the least, not all of it. It seems to me that Buiter believes that should happen fairly soon.

Perhaps, if you could explain to me how Ecuador, I think it’s Ecuador, can just decide it doesn’t want to service a debt, and seems to be getting away with it, I might see this option as more unlikely in the US. Instead, I can see the idea catching on. Maybe California will tell us something about how the US feels when it gets into a real fight between cutting costs and raising taxes. Frankly, I’d pay good money to see Arnold play Correa:

“Monday, April 20, 2009
Ecuador says wants debt buyback at a “big discount”

QUITO, April 19 (Reuters) – Ecuador will offer investors of its defaulted debt a buyback with a “big discount” on its nominal value, President Rafael Correa said on Sunday.

Ecuador plans to reveal its debt restructuring proposal on Monday, more than four months after the leftist Correa refused to pay $3.2 billion in 2012 and 2030 global bonds over charges the debt was “illegally” issued by past administrations.

“The proposal is basically to try to buy back that debt at a big discount,” Correa said during a television interview. “The source of the debt’s illegitimacy was its overvalue when it was renegotiated in 2000 at a time (when) our country was in shambles.”

Correa, a former economy minister whose presidential campaign slogan was “life before debt,” has said his government could seek a buyback at a price similar to the market value of the defaulted debt when it was restructured in 2000.

Correa said the global bonds, which were issued as part of the 2000 renegotiation, were valued at around 20 cents on the dollar at that time when a crippling financial crisis forced Ecuador to default on its foreign debt.

Even as Ecuador’s revenue plummets on lower oil exports, the U.S.-trained economist has said the OPEC-member nation has enough funds to buy back the defaulted debt.

Local media has speculated his socialist government silently bought back a large percentage of the debt when Correa threatened to default in November. If Ecuador controls a great part of the debt the cost of a buyback will be much lower.

The debt restructuring plan also comes only days before Ecuadoreans decide whether to re-elect Correa in general elections. Some analysts say Correa will seek big concessions from bondholders in the restructuring to boost his popularity before the April 26 vote.
The debt default has shutdown international credit lines to Ecuador and its private businesses at a time when the government is scrambling to cover a widening fiscal deficit this year.”

In looking up this post, I came upon the following blog:

http://www.jubileedebtcampaign.org.uk/Ec uador+4044.twl

Torah!Torah!Torah!

I also came upon a blog called “Ecuador Rising” that’s worth a read, but I’m not linking to it because I’ll turn up as a bot. Did ‘bot’ come from ‘robot’? I’d like to know, because I’m trying to answer Steve Hsu’s question to me on his great blog “Information Processing” if a robot can discover that it’s a robot.

Can a debt get too big to pay.

“YES”

Then you go to debtors prison.

Posted by f belz | Report as abusive

Billion – Trillion, what’s a factor of 1,000. Ironic considering your prior post. It does seem weird to contemplate a GDP of $560 Trillion, but what is Japan’s GDP in Yen? Y500T? That seems like some sort of code…

Posted by winstongator | Report as abusive

Felix, are you trying to prove the point you made two posts ago? You’re confusing billions and trillions in your calculation paragraph…

I hope this was intentional…

Posted by Guillaume | Report as abusive

Actually, our national debt is already too big to repay, which is precisely why it continues to grow. In the last seven years, our national debt has grown at an annual rate of about 9%. At that rate, it would reach one quadrillion dollars in 53 years. And, if anything, the rate of increase in the national debt is rising, not falling.

In analyzing the national debt, you make the same mistake made by economists when you express it as a percentage of GDP. The problem is that it’s not the GDP that will have to repay the debt, it’s taxpayers. While the national debt, as a percentage of GDP, is far below its record level of 120% in 1945, when expressed in per capita terms (and adjusted for inflation), it’s at record levels and rising fast.

And, while GDP may be increasing at a rate of 8% per year, taxpayers’ incomes and net worth are not. Median family income is lower today than it was in 1969 and median family net worth is lower than it was in 1976. In 1976, each family’s share of the national debt was about 35% of their net worth. Today each family’s share exceeds their total net worth by about 20%. In 1976, all of our national debt was held by American citizens in the form of savings. Today, virtually every new dollar of debt issued is to foreign entities who could demand repayment at any time.

You say that there is no currency mismatch between our tax revenues and our liabilities. True enough. But there’s an enormous mismatch between our liabilities and our ability to collect enough revenue to cover them. And it’s rapidly getting worse. Your reader has good reason to be concerned.

Whilst you point out that there is only a tiny proportion of inflation linked bonds, your not thinking dynamically, in a high inflation or volatile inflationary enviroment investors may demand inflation linked bonds thus increasing there portion weight.

Posted by Chris Allison | Report as abusive

The Peter G. Peterson Foundation (http://www.pgpf.org/) was established to approach this exact problem. The problem is not whether we can pay it off but whether we will be able to keep it at a manageable level. There is an excellent 30 minute movie that gives the 50,000 foot overview of what this all means, including the relationship of GDP to debt. http://www.iousathemovie.com/
The CIA’s web site is also a great place to go to see where we are in relation to other developed and developing countries:
https://www.cia.gov/library/publications  /the-world-factbook/rankorder/2186rank. html

Posted by Anne K, Richmond, VA | Report as abusive

Infalation rate of 2.5 to 3% a year? That is a big “If”.

In 1970, house price was about $9,000 on average, 40 years later, it is $200,000 on average. What is the percentage of price increase in houses? 3% or 10%?

Error! Error! You’re mentioning GDP everywhere in billions. It should be trillions!. 650 billion GDP in 50 years? :)
We were at that level some 30 years ago! :)

Posted by Donaldo | Report as abusive

We are bad in math. Pres. Obama proposed 3.5 trillion budget, and save 17 billion in spending. Sounds 17 is big than 3.5? we are in good shape. Do we need compare numbers in same units? Normal people will think 17 is a bigger number.

Where is the change in washington? We see banks being bailed out with our money. What about the American people? Read the Article…http://newamerica-now.blogspot.c om/

@Pete Murphy: The GDP is not growing at 8%, but might do so in the future. If it does, average income will do so as well. The median household doesn’t pay nearly as much in taxes as the mean household (insofar as sense can be made of that).

I assume Felix is familiar with the Carter administration’s foray into bonds denominated in foreign currencies. I don’t see why it couldn’t happen again if dollar-denominated debt gets extensive and the dollar starts to sag.

There may be a better question. How much of the debt we have today cannot be paid back? My two cents says it’s about $21 trillion.
Enjoy your weekend.

http://www.thenewmortgagecompany.com/apr ilfools.html

Felix, I believe you should think outside the box occasionally. If the US debt becomes so big that the interest payable will be higher than the GDP, then the US will never be able to repay the loan. Moreover, the debt will keep growing fast due to compounding interest. What if, at some point in the future the US dollar will lose its status of World Reserve Currency? You think this is far fetched? At present, the US is behaving like a spoiled brat that believes the world owes him everything. It takes everything for granted and it believes the all is well… But all is not well. As someone said before: “If you’re not petrified, you’re not paying attention!”

Posted by Morphius | Report as abusive

Why is everyone looking at in a funny way, why not be simple? Ok we have $11 trillion debt,the government takes in around $3 trillion in revenues a year now,plus we borrow more each year because of spending, right now we use about 30% of total government revenues to just service the debt, thats interest alone, we don’t touch the principal. If we continue to spend more than we take in as we currently do, one day it will be 50% of all government revenue and sooner or later we will have to raise taxes to 90% to cover the spread. The truth is the debt is based on what we can pay as taxpayers, if it gets to high we will have to default, because taxes are already too high and a governor on economic growth, big debt will strangle the economy sooner or later.

Posted by Jimmy | Report as abusive

Felix,

Your answer is completely aside your question. You answered on the question “Can America’s debt get so big that the country defaults”. Of course the US will not default. However you question was “Can America’s debt get too big to pay?”. The answer on that question is clearly “Yes”, Jimmy’s argumentation is headon.
Try to make a model which proofs that the US will ever be able to ever pay down again a part of it’s principal; impossible. Now that people are fleeing dollars and treasuries, this will further compound the US problems.

Posted by JB | Report as abusive

It seems to me most of the previous comments answer with a resounding YES to “can the US default on its debt?”

Posted by Sylvain | Report as abusive
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