This week, on Retire Your Way Radio, I talked about the U.S. national debt, why the debt ceiling doesn't really matter, and the role of Modern Monetary Theory.
Is anyone worried about the national debt? It often comes up in talking points on TV and online through various social forums and even in conversations.
How will the U.S. government be able to pay off $28 trillion in debt?
That’s a huge amount of debt to have sitting on a balance sheet, but it’s not as big of a problem as mainstream media and politicians make it out to be.
Listen to Episode 38 Here:
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Not All Debt is Not Created Equal
As an example, let’s compare someone with $100,000 in credit card debt to someone with a $100,000 business loan. Both people have the same amount of debt.
In this example, the person with credit card debt has accumulated that debt over time by overspending and not using a budget.
The person with business loan debt used the money to start a company that hypothetically provides jobs to 10 people and generates $1 million in revenue every year. That person even had another business offer to buy their business for $3.5 million.
The original $100,000 business loan was used to build an asset that is helping the local economy. This is a great way to use debt.
Someone who has accumulated the same amount of credit card debt is not using debt in a great way.
How do we determine which debt is better?
In the situation with the business owner, we looked at both sides of the balance sheet to compare assets and liabilities (or debt). We also considered the economic output of jobs created.
Perhaps you have a $500,000 mortgage but your house is worth $1 million. If you subtract your debt from your assets, you have a positive net worth of half a million dollars.
A $500,000 mortgage is a lot of debt on its own, but in this situation, we also looked at the other side of the balance sheet.
Now let’s look at the choice to increase debt.
Let’s say the business owner turned down that $3.5 million purchase offer and decided to take on another $100,000 in business loan debt to hire an engineer to expand the business even more to be worth $10 million.
Both sides of the balance sheet are expanding.
The balance sheet of someone with credit card debt is also expanding, but only on the debt side. The increase in debt is not helping to increase assets or cash flow.
We don’t often think about things this way when evaluating the U.S. debt. We hear $28 trillion and wonder how the government will ever pay that back.
But there is another side to the balance sheet, and the U.S. has the highest market capitalization in the world at just over $40 trillion.
There are two sides to everything.
All of the money in our economy is an asset for one person and a debt or liability for another.
For example, U.S. treasury bonds are a liability to the government but an asset that produces income for retirement savers like you.
When you pay off your mortgage, you remove a debt, but the bank also removes an asset.
In the long run, we want our government’s balance sheet to expand because, as our economy grows, we will likely need to invest in more law enforcement, military, schools, infrastructure and other areas.
We will need to incur debt to fund our needs.
The Debt Ceiling
Cullen Roche of Pragmatic Capitalism uses 6 steps to summarize the U.S. government’s debt ceiling process:
Step 1. Congress establishes a debt ceiling, which is a fake limit on how much debt the country can issue.
Step 2. Congress approves new legislation that will require more debt in the future.
Step 3. That legislation causes a breach in the debt ceiling.
Step 4. Congress pretends they are going to default and shuts down the government for a week or two.
Step 5. The debt ceiling gets raised because previous legislation approved by Congress forces Congress to raise the debt ceiling or default.
Step 6. Lather, rinse, and repeat as needed.
Roche also says, “the debt ceiling isn’t instilling any discipline in the way we manage the national debt. Instead, it’s just creating an annual charade, causing unnecessary shutdowns and uncertainty around the bond market.”
Modern Monetary Theory
One of these things is not like the other:
- State and local governments
- The federal government
The first 3 must all raise money in some way before they spend it.
The federal government is different because it can issue currency. State and local governments need tax revenue to operate, but the federal government does not.
Congress didn’t go out and find money before passing COVID relief packages. The relief payments sent to individuals and families were paid for with new money.
Instead of asking “How will we pay for this?” Modern Monetary Theory says “How will we resource this?”
As long as we have enough resources including labor, factories, machines, and materials, the government can spend more money.
It becomes a problem when we are operating at full capacity and there is not enough for everyone to buy, which causes inflation. At that point we will need to dial back government spending and possibly adjust interest rates.
What I hope you get from this is that there is more to this never-ending story about government debt than what we see in the media and hear from one side or the other on the political spectrum. The fear of a government default is used because of a political agenda or to get viewers’ attention and get clicks on headlines.
So, just remember that debt isn’t necessarily bad. The illustrations above are why I’m generally not overly concerned about our national debt unless we have high inflation.