As part of the latest stimulus package, the US Congress is set to authorize an expansion of the total US debt limit to a whopping $12.14 TRILLION!
This staggering number includes all the provisions of the latest $789.5 billion economic stimulus plan, as well as other potential government liabilities that were part of last year’s $700 billion bailout package and the conservatorship of government sponsored mortgage giants Fannie Mae and Freddie Mac.
So, the multi-trillion dollar question is: How much debt is too much? Is the enormous US government debt load sustainable? Are we teetering on the brink of catastrophe and the collapse of our entire economy?
One way to answer these questions is to compare our debt burden with the size of our economy, and figure out our “debt ratio”. It’s like this:
Imagine you are buying a home and you are trying to figure out how much of a mortgage you can qualify for. Your lender will look at your credit rating, your income and how much cash you have in the bank to determine whether or not you are likely to pay back the mortgage loan over time. For example, if you make $140,000 per year, it is not wildly inconceivable that you could potentially qualify for a $120,000 mortgage loan. In fact, you could probably qualify for a much larger amount without a problem!
It’s the same thing when countries and governments borrow money. One very good measurement of whether a country is carrying too much debt on the books is its debt ratio – how much debt the country has compared to the size of that country’s national economy. So, let’s run the numbers on the USA and see if we can figure out a debt ratio:
Step # 1 – What is the size of our debt again?
Well, it depends…
If you include the more than $5 trillion of liabilities from government sponsored mortgage giants Fannie Mae and Freddie Mac, the remaining funds from the $700 billion bailout that have not been spent, and the new $789.5 billion stimulus package, our debt burden would reach the latest ceiling of $12.14 trillion.
However, that number is somewhat deceptive because it includes over half of all residential mortgage loans outstanding in the United States, secured by the homes of US homeowners. There is no way in heaven, hell, or purgatory that home values in the United States of America are going down to $0, and the $5 trillion of loans owned or guaranteed by Fannie and Freddie will end up completely worthless.
So, if you back Fannie and Freddie out of the equation, the US debt burden is closer to approximately $7 trillion. Still not exactly chump change.
Step #2 – What is the size of our economy?
The US has annual Gross Domestic Product (GDP) of $14.5 trillion. Basically, this means that the US produces about $14.5 trillion of goods and services each year, and this is the size of our economy.
Step #3 – What is our total debt burden compared to the size of our economy?
If you don’t include Fannie and Freddie, the total US debt ratio is approx. 48%
($7 trillion total US debt / $14.5 trillion annual size of US economy).
If you do include Fannie and Freddie, the (as yet) unused bailout funds, and the latest economic stimulus package that is likely to pass in the next week or so, the US debt ratio would be 83.7%
($12.14 trillion total US debt ceiling / $14.5 trillion annual size of US economy).
In other words, in even the worst case scenario, this would be (almost) equivalent to a homeowner who makes $140,000 per year qualifying for up to a $120,000 mortgage.
Is this too much debt? You tell me…
The debt ratio seems modest in your comparison compared to the GDP, but why use GDP instead of annual tax revenues? Using the GDP and implying the dept ratio is modest also doesn’t account for that fact that in essence the Government is taking out this loan for you.
If I walked in to a bank, and wanted a “regular” loan for someone making $140k, say one million. During the interview I tell the agent I already have a little mortgage of $120, but there is no equity, the rate could go up to anything at any time, and could even result in another loan whether I agree or not. Besides that I already have most that $140 tied up in other liabilities. How impressive is that?
It’s not so pretty, or modest all of the sudden.
Your comparison also assumes the GDP is fixed. What if the mechanics of the Pork Bill cause the GDP to shrink? Or a better question; what is growing faster, our private dept or our GDP?
So yes, the debt is too much, if not in dollars and cents, its volatile unknowns.
Another good post. I posted a plug for your blog at mine. Anyway, I am sure most people forget the points you are discussing.