When Is US Government Debt Too Much?
The definitive answer to the timeless and often poorly answered question, when does US government debt become too much?
“How much US government debt is too much debt?”
At face value, this seems like a very simple question, yet there doesn’t seem to be any satisfactory answers out there.
Time and time again, I have heard financial media talking heads struggle with this question, either sidestepping it altogether or giving indirect answers.
For example, David Friedburg, one of the 4 hosts of the largest (probably) finance and tech podcasts out there, the All-In Podcast, posed this question to his fellow hosts in an episode a few months ago.
None of the podcast’s centi-millionaire/billionaire hosts gave a good answer to the question.
I found this very surprising.
These podcast hosts are incredibly accomplished, wealthy, and intelligent people, yet this question stumped them.
This newsletter issue aims to correct the record. I’ve pondered on this question for a while and I think I’ve reached a pretty definitive answer.
So, without further ado, let’s answer the question: how much US government debt is too much debt?
💡 Bad Measures
Before discussing the answer, let’s go over some commonly thrown around but, in my opinion, ineffective measures of US government debt.
They include:
Raw debt level (the US government has about $34 trillion of debt as of writing)
This is probably the worst measure of US government debt to gauge when it has become Too Much.
US government had $6 trillion of outstanding debt in 2001.
$6 trillion sounds unwieldy. $11 trillion in 2008 sounds even worse. $20 trillion in 2017 is daunting. $28 trillion after the pandemic must be catastrophic, right?
Yet here we are today with $34 trillion of outstanding debt.
The US government still has its lights on, the US Dollar is still the global reserve currency, and your neighborhood McDonald’s stands ready to take your order.
The total debt number is meaningless.
Debt-to-GDP ratio
The debt-to-GDP ratio is another popular metric to gauge the level of a country’s indebtedness.
This one is quite meaningless too, especially for the United States, i
If one wants to understand when debt levels are too high, this one is quite meaningless too, especially for the United States
I’ve shared a chart of the US’s debt-to-GDP ratio below showing data from the late 1960’s to today.
The ratio went from 60 to over 100 between 2008 and 2020 and it’s now 120. When is it too high?
150? 200? 300? Who knows.
Japan’s debt-to-GDP ratio is at over 210 right now and the country is nowhere close to a debt crisis. The falling Yen might seem like a problem but it’s really by design.
A controlled demolition, if you will, as a way to boost exports and spur inflation.
Fiscal Deficit as a Percentage of GDP
The fiscal deficit as a percentage of GDP is yet another measure of government indebtedness. It’s also Not Very Useful for the United States government.
The US has been running a deficit since the turn of the 21st century.
Like the US, Japan has been running a persistent deficit over the last couple decades.
How long and how deep can the US government run deficits for? Who knows.
Cutting To The Case
Below is what I think are the best measures to tell when US government debt is too much. They’re simple, yet effective.
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In the past few issues, I’ve written about:
Summarizing rare and prescient market insights from two legendary investors
How the Federal Reserve is being torn asunder by a global tug of war of epic proportions
How multi-strat hedge funds are so wildly and consistently profitable
Why the US stock market won’t stop rising despite interest rates being at multi-decade highs
How the US Treasury rebelled against the Federal Reserve to stimulate the financial system
How the Bank of Japan is able to print an infinite amount of money without crashing the Yen
Interest expense as a % of the total budget
Occurrence of failed treasury auctions
When government interest expenses get too high (especially when interest rates are high), more and more of the budget needs to be funneled just to service interest expenses.
This is Not Good.
A Catastrophic Debt Spiral happens when this gets out of control and interest expenses subsume the budget. In this case something drastic, like a debt default, needs to be done to save the government from the impossible debt burden.
The measure, interest expense as a % of the total budget, is great as a way to watch out for when interest expenses are close to subsuming the budget.
The second measure, occurrence of failed treasury auctions, is also a very effective measure.
The US Treasury raises debt by selling treasuries through treasury auctions. It runs many many auctions a year. In each auction, the US Treasury has a target amount of debt it plans to raise.
When the Treasury has to raise a lot of debt, the frequency and sizes of auctions increase.
A failed treasury auction occurs when demand for the offered treasuries in an auction is so weak that they can only be sold off at absurdly high interest rates.
Historically, treasury auctions don’t fail. If one fails, it’s a Very Bad Thing and will instantly crush confidence in US government debt.
In Q3 of this year, the US Treasury needs to raise $847 billion in new debt ($2 trillion of new debt for the year).
$847 billion in new debt means the US Treasury needs to hold many many large treasury auctions. The larger and more frequent auctions are, the greater the chance of one failing.
It’s hard to tell when exactly buyers have lost appetite for treasuries and don’t show up to an auction.
The Bottomline
US government debt is too much when:
Interest expenses become an uncontrollably growing portion of the budget.
When a treasury auction fails because the US Treasury has been offering too much debt to a market that can’t absorb the supply.
I want to lock in my answer before reading and reflect on it afterwards to see what I learn.
My answer: It becomes too much debt when we lose trust it will be repaid.
I don't think there's a specific dollar amount that is too much, I just think the point of debt is having trust it will be repaid and that's why there's a credit rating. Losing your credit rating is an indicator that creditors are losing trust and that the system is degrading.