Diving Into Debt

While not yet passed, additional stimulus to the tune of over $1 trillion is on the horizon. This brings up the question:  Should we be worried about the U.S. deficit?

The deficit, the difference between the government’s expenditures and its revenues, was a concern for many even before the pandemic stimulus bills were enacted in 2020.  Back in what seems like forever ago (2019), the deficit stood at $984 billion and represented 4.6% of Gross Domestic Product (value of goods and services produced in a given year).  Then we encountered a global pandemic, and along with it, the U.S. government’s largest economic rescue in our history. By the end of 2020, the deficit grew nearly fourfold to $3.7 trillion. Now into 2021, the Congressional Budget Office has increased projections for the year from 4.7% to a much larger 16%.

Source: Congressional Budget Office, An Update to the Budget Outlook: 2020 to 2030, September 2020 Update, Page 1

The current deficit is almost twice what we experienced in the Great Recession of 2007-2009 and well above the average deficit to GDP for the last 50 years of 3%.

While the significant increase can be alarming, it could be argued that the deficit increase was a necessary evil.  The increased spending in 2020 did what it was supposed to do, preventing a continued spiraling of the markets and economy along with relief across the nation. However, deficits are only one thing. They are a year-by-year measure of whether debt is being added to or paid down. We also need to be mindful of our total debt level below.

Source: Congressional Budget Office, An Update to the Budget Outlook: 2020 to 2030, September 2020 Update, Page 2

You can see the massive spike in the graph above caused in many ways by two crises, one financial and one medical. The stimulus bill on the table now debated in the House is nearly two trillion dollars, which is big no matter how you cut it (the entire debt in the U.S. back in 1981 was $1 trillion).

So, should you be worried about the debt?

The short answer is no, at least in the short-term. If we tried to decrease debt now, that would mean either less spending or more revenue (tax). In the economy, we are still recovering, so too much of either of those adjustments would likely highlight the fragility of the economy.

The other piece to know is the debt is counterintuitively extremely affordable. Why? Because interest rates are so low. The government is borrowing funds for peanuts. So, while we are increasing debt, the payment on the debt is smaller. About ten years ago, our overall debt was at $14T.  Today we are over $26T. However, as you can see below, rates are down. If we crudely assume a 10-year interest rate on the debt levels, debt payments each year are almost 25% less than they were a decade ago, even though debt is nearly doubled.

Source: YCharts. Data from 3/31/2011 through 1/27/2021

Sure, that could change if interest rates spike. However, there are many global reasons they can stay low. After all, we aren’t the only country out there holding to incredibly low rates.

Inflation may be another concern, yet the Fed has many tools to battle against inflation, and inflation is hard to come by when you still have employment issues.

The other issue is a growth slowdown. This may eventually happen. By borrowing so much money, we, in a way, may be borrowing future economic growth and making it happen today rather than 10, 20, or 50 years from now.

This all will eventually need to get figured out. What does this mean now? Two things as we think about a portfolio. First, diversification across countries makes sense. We all have a different growth and debt journey ahead, so diversification will matter. The other is on the types of bonds that are held. There is value in U.S. government debt, but also other opportunities out there to stay lower risk and be diversified here as well.

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