Strange Debt: How I Learned To Stop Worrying And Love The Debt Bomb

What could be stranger than realizing a commonly understood and accepted truth is in effect nonsense? Imagine if the Aztecs, who happily sent their young up the pyramid to be horrible killed for a bunch of mythical lizards, realized their sacrifices were for naught. Or imagine the reaction of those that believed the world was flat or perched on the back of a giant turtle if suddenly they were clued in to the fact that our planet is a ball of warm rock travelling at incredible speeds though a huge ancient void filled with stuff thrown out by a giant explosion. They would certainly be taken aback.

What if you learnt that the U.S., or for that matter the U.K., national debt was almost as mythical as the monstrous Kraken chained at the bottom of the ocean by the Greek gods? You might be a little surprised.

Well, prepare to be incredulous or at least a little perplexed. Let’s open up the can of worms but first try to be open to the possibility that the U.S. national debt is not the economy killer it is laid out to be.

The U.S. national debt is about $37 trillion, call it $100,000 a head, a cool $250,000 per taxpayer. How could this not be a crusher for the generations ahead, how could this not be a burden already too heavy for the hard pressed abused donkey of the U.S. population to bear?

Well, it’s simple. 70% of the national debt is held by Americans.

Seventy percent of that scary national debt is an asset to Americans, not a crushing liability. It’s a liability of the U.S. government to the U.S. people. The U.S. doesn’t owe 70% of its total debt to foreign nations and meanwhile the share of the U.S. national debt owed to foreign parties is actually falling. Most of the money borrowed by the government to spend on its citizens, actually comes from them and to them the debt is an asset, on which they get paid interest.

And wait, those citizens pay tax on that interest, so a fat slug of it goes straight back to the government, cutting down the real interest cost in a single blow. Then hold on a minute, not only is the bulk of the principle and the bulk of the capital lent by Americans to be spent on Americans, but the principle is also likely to be being nibbled away by inflation. As time passes, that debt gets ground down into less and less importance not only by inflation but by growth. In summary, the scale of the national debt to worry about, is only 30% of the size of the topline number we all get bombarded with as the agent of the next economic cataclysm.

So when you hear someone say the debt will kill America, you can imagine that the bulk of the figure being bandied about is simply a ledger entry between one bit of the U.S. and another and it is in no way a load of the U.S. economy because it is just money going around a closed loop. Look at it this way. You save for your retirement, you buy a Treasury bill, Uncle Sam isn’t closer to bankruptcy, he just prints you some money, you buy groceries and life goes on. But wait, print money? Surely that’s inflationary. Yes, no and maybe. Crudely, as long as money supply is not running ahead of grocery supplies, it is not creating price inflation; what’s more, if you tie up cash in a bond, it actually can be deflationary, it can actually be quantitative tightening. This is because the cash that was burning a hole in your pocket is now tied up in something less liquid and doesn’t go shopping down the mall looking for trouble.

This will hurt the heads of many.

Long story short, the real national debt is the part of “the national debt” the nation owes to other countries and this is 30% of the top line figure. This is why even though the national debt has been declared as an oncoming economic catastrophe by pundits since I was a child in the 1960s, it actually hasn’t happened.

Now this is not to say a big national debt can’t be an economic killer, but this trouble occurs when countries borrow from other countries in a currency not their own. If you are Argentina and you borrow billions in U.S. dollars to buy stuff from overseas, then you really do have a problem pretty fast, because foreign creditors will get salty if you don’t pay them back on time in money you can’t print yourself. Funnily that tends to happen quite a bit. However, if you borrowed in your own currency from your own people, like the Japanese, then all you do is print another lot of paper with cash-like properties and you are good. This near-money is as good as cash and almost as fungible, that pays interest and everyone is happy to hold it instead of cash because cash pays less. People love holding government bonds, it is a highly recommend investment strategy, it’s investment 101 after all. What is not to love? If a government is selling its bonds to its own people who are happy to hold them, then it’s not exactly clear how high a national debt can be and to demonstrate that, the Japanese have pioneered it and their government makes it work at a national debt level that represents 263% debt to GDP, that’s roughly x2.5 the U.S. level.

You might say it’s not the national debt you need to be scared of, it’s the international debt that’s the killer and for the U.S. and the U.K. it’s about 30% of the headline number. So, when you hear the numbers, the real number is a small fraction of the total and then suddenly an unsupportable debt mountain suddenly become a foothill.

Perhaps don’t tell the politicians but as an investor it’s good to know that the economy you are investing in is not actually hanging off the edge of a debt precipice, because about the most damaging thing an investor can do is to be scared off from investing by arguments that are based on misconceptions. You might disagree, but when the financial world nearly stopped spinning in 2008 when exactly did people stop telling you the world economy and the U.S. economy were finished and you’d be a fool to invest in stocks again? The answer is they never did. If you took that doomsday advice you would be bitter and poorer and none the better off for the next anxiety filled bullish 16 years. 16 years where it was all going to come unstuck, crash and burn etc.

It didn’t and once again going forwards it’s going to be okay.