The national debt is a topic on which there are many myths and false narratives. Here’s the truth, confirmed by countless examples from throughout history and from other contemporary nations: Countries that run high and rising public sector debts invariably end up undermining their own economies as well as their geopolitical position in the world.
America’s national debt is on track to grow exponentially for the rest of this century and beyond. It poses a clear and present danger to our nation’s economy. It’s time to address it.
America’s national debt is now as high as it’s ever been as a share of the nation’s economy, at just over 100% of GDP. But isn’t it likely to stabilize and stop going up at some point?
Not if we remain on our current fiscal path. Federal spending is on track to grow as a share of gross domestic product (GDP) for many decades to come, according to projections by the Bureau of the Fiscal Service, a unit of the U.S. Treasury. Federal tax revenues, meanwhile, are likely to remain roughly constant as a share of the economy. Official projections show America’s debt-to-GDP ratio rising exponentially, to more than 500% of GDP by 2100.
How do high and rising debt levels affect a nation’s economy over time?
History teaches that nations with excessive public sector spending and rising debt have consistently undermined their own economic growth in three ways: by crowding out private sector investment, by underinvesting in long-term public sector priorities as a result of rising debt service costs, and by sparking financial crises as investors come to doubt the government’s creditworthiness.
Over hundreds of years, nations with debt exceeding 90% of GDP over a prolonged period have seen considerably slower economic growth than less indebted countries, economists Carmen M. Reinhart and Kenneth S. Rogoff show in their book This Time is Different: Eight Centuries of Financial Folly.
But does public debt really matter for a nation like the United States, which can always print more of its own currency?
Yes. It’s true that nations that print their own currencies can never run out of money and be forced into default on their debts. But throughout history, such nations have frequently experienced severe financial crises from ruinous inflation or other disguised ways of walking away from their debt obligations.
Why?
When nations persistently engage in excessive government spending and pay for it in part through money printing, rapid growth in the money supply usually leads to high inflation rates and destroys the confidence of citizens and other investors in the national currency. Excessive government spending also crowds out private sector investment regardless of how it’s paid for, since the economy’s available resources are always finite.
Don’t we just owe most of the money to ourselves?
A dangerous oversimplification. A fiscally unsustainable public sector poses significant risks for the nation regardless of who owns the government’s bonds – that is, regardless of whom the government owes money to – contrary to a popular narrative that it doesn’t matter if we “owe it to ourselves.” More than half of outstanding U.S. Treasury securities are owned by private sector funds, financial institutions, and state and local governments, all of which would face financial catastrophe if the federal government undermined the value of these holdings through high inflation.
Also, just under a quarter of the federal government’s obligations are held by foreign governments and institutions, prominently including the Chinese government and several Middle Eastern oil exporting countries. Interest owed to foreign bondholders will undermine domestic investment more and more in future decades.
Can’t America grow its way out of the national debt?
Very likely no. We estimate America’s economy would have to grow roughly between 5% and 6% per year for the rest of this century – compared with about 2% per year over the past three decades – to stabilize the nation’s debt-to-GDP ratio at something like today’s 100% level, based on a simple model using standard federal government assumptions regarding spending, tax revenues, and interest rates. While it’s possible that AI and other significant innovations will boost economic growth to rates faster than we’ve experienced in the 21st century, it’s far too early to project rates as high as 5%. Most economists expect a positive but much more modest acceleration as a result of AI.
But isn’t the United States different because it’s the world’s leading great power?
History confirms that high and rising public sector debt levels undermine the economies even of the most powerful nations over time. The Roman Empire, Imperial Spain, 18th century France, Qing China, and the British Empire in the 20th century all undermined their own economies and experienced long-term geopolitical decline in large part because of excessive spending, currency debasement, debt repudiation, and underinvestment in essential long-term priorities. You can read more about the economic fall of these great powers here.
But isn’t the United States different because the dollar is the world’s leading reserve currency – that is, the principal currency held by foreign governments to finance international trade and other expenses – so other countries will always help fund America’s debt by buying U.S. Treasury securities?
Not in the long term. One nation after another has lost its position as issuer of the leading reserve currency when foreigners came to doubt the currency’s reliability as a store of wealth. Changing financial technology is also making it easier for countries to diversify their foreign exchange reserves, while the U.S. government’s aggressive use of financial sanctions against foreign rivals has fueled growing interest in developing nondollar mechanisms for conducting international trade. The dollar now represents just over half of the foreign exchange reserves held by governments around the world, far below its late 20th century levels and about 10 percentage points below where it stood in the mid-2010s.
Does historical evidence validate the idea that high and rising debt crowds out the private sector as well as long-term public investment?
Yes. Imperial Spain, Europe’s leading nation-state in the 16th century, experienced decline in its urban commercial centers, underinvestment in waterways and universities, and a collapse in the monarchy’s credit by the early 17th century after decades of massive borrowing to finance the empire’s military campaigns. In 18th century France, the “Sun King” Louis XIV’s excessive spending on foreign adventurism and his lavish court at Versailles set back French industrialization, destroyed the nation’s creditworthiness, and generated acute fiscal crises ending in catastrophic violence and revolution after 1789. In 19th century China, overspending on a sprawling imperial administration meant that the empire underinvested in canals and irrigation. Iron furnaces that had been in operation for 800 years closed, and the few private sector firms that came into existence failed for lack of capital.
But does evidence from the 20th century confirm these lessons?
Yes. 20th century Britain became the first leading great power to undermine its economy through overspending on social programs rather than armies and bureaucracy. Starting in the 1920s but particularly after World War II, Britain dramatically boosted spending on public housing, pensions, healthcare, and other welfare priorities. The resulting crowd-out meant the country invested less than comparable nations in education, research, infrastructure, and private industry. Living standards fell behind those of most Western European nations by the 1970s. Meanwhile, economic stagnation weakened the British pound’s position as a leading reserve currency in the 1930s and ended it in the 1950s.
But doesn’t 21st century Japan show that a wealthy modern country can sustain debt levels much larger than America’s current level without paying an economic price?
No. While Japan’s gross debt-to-GDP ratio is well above 200%, its net indebtedness is far lower, as the government holds a large stock of financial assets through the nation’s distinctive social security system and government financial institutions. Unlike America, Japan has financed itself almost entirely by domestic borrowing due to historically high savings rates. Japan has also taken decisive steps to curb spending, and its debt-to-GDP ratio is trending down. The larger story is that Japan has paid a considerable price for extravagant past spending and borrowing. Investment in education and research has fallen behind other leading economies, while venture capital investment and new business creation have languished. Living standards in more frugal Singapore, South Korea, and Taiwan have either surpassed or will soon surpass Japanese levels.
Do overindebted countries ever successfully reverse course?
Yes. History shows that countries with sound institutions can achieve “fiscal consolidation” – that is, long-term paths back to sustainable finances. The late economist Alberto Alesina documented many examples of fiscal consolidation. The most durable debt reductions, he found, have typically resulted from sustained spending restraint rather than tax increases.
Among historical great powers, 18th and 19th century Britain offers the most compelling example. Britain emerged from its failed war in America and its victorious war against Napoleonic France with extraordinary debt levels, but exercised spending restraint and rapidly reduced indebtedness after both conflicts. It then maintained a political consensus for fiscal discipline for 100 years, even through imperial expansion and growing spending on Victorian Era social programs.
But can fiscal consolidation succeed in contemporary democratic nations?
Yes. Sweden, Denmark, and Finland, which experienced severe financial crises in the early 1990s after two decades of galloping growth in social spending, each arrived at a consensus in favor of fiscal prudence and launched successful initiatives to reform their welfare states. Sweden has reduced its debt-to-GDP ratio to less than 30% from 70%, while Denmark has achieved zero net indebtedness, after counting government assets. Fiscal restraint commands 80%-plus public support throughout Scandinavia today. To be fair, it’s likely true that relatively homogeneous, small societies like the Nordic countries have advantages over a large, diverse nation like the United States in forming a consensus around national policy priorities.
Is there something about America’s history or institutions that pushes the nation onto a less sustainable fiscal path than other countries?
No. Despite its long history of political contention, America has long had one of the world’s best records for fiscal responsibility, until recently. The U.S. government achieved remarkable declines in indebtedness after the Revolutionary War, the Civil War, and the two world wars of the 20th century. From the late 1940s to the 2000s, America’s debt-to-GDP ratio remained consistently lower than that of most advanced economies, even though the United States devoted more of its GDP than most to national defense. America sustained this track record of discipline from the 1980s to the 2000s through a series of compromises, including the Social Security reform of 1983, the Gramm-Rudman-Hollings Balanced Budget Act of 1985, the tax reform law of 1986, and the Obama-Boehner spending deal of 2011. As far as fiscal responsibility is concerned, today’s pattern of explosively rising debt is the exception, not the rule.
But wouldn’t possible fixes impose draconian costs on the American people?
No. Budget experts have proposed a wide range of plans that would put America on a sustainable fiscal course with relatively modest changes to major federal programs and reforms to reduce tax loopholes and deductions. While it may seem strange to suggest that a very large debt problem can be addressed through undramatic measures, what makes the math work is the power of compounding over long periods of time: Modest, achievable savings – if continued for decades – would add up to enormous improvements in the nation’s fiscal trajectory.
