One of the side-effects of dealing with the 2020 pandemic is an increase in national debt levels. This goes totally in the opposite direction when compared to households.
For instance, households increase their debt levels when they are optimistic about the future and increase their savings rate when pessimism dominates. In the case of governments, it goes the other way around most of the time.
However, governments should be viewed as households – with incomes and expenses. If the government runs a deficit (i.e., spends more than it produces), it must finance it by borrowing. Or building up debt, just like households do.
Yet, the chart below shows that the United States, the world’s largest economy, built up debt both before, during, and after the economic crisis.
Consequences of Rising Debt Levels
A country that runs a trade deficit has no other option but to keep issuing new debt. Everything is OK as long as the economy can support the new debt as it comes at a cost (i.e., interest). Therefore, one of the ways to measure a country’s debt sustainability is to compare the debt level to the Gross Domestic Product (GDP). The latter reflects what the company has produced in terms of goods and services in a period – this time, a year.
The higher the debt-to-GDP ratio, the more difficult it would be for a country to service its debt. Credibility matters here.
Imagine that the debt-to-GDP in the United States will keep rising. It reached close to 280% in 2020 in response to the pandemic. If at some point, the U.S. will have a problem servicing it, investors in the U.S. debt will lose trust.
How can a country bring down the debt level? One way is to become more productive. However, this is the hard way, meaning to produce more efficiently so that the GDP grows faster than debt does. As the chart above shows, since 1981, this has not been the case in the United States.
Another way is to debase the currency. After all, if the debt is issued in the local currency (i.e., the USD), by debasing it, it becomes easier to service the debt as the monetary authority has full control of how much it prints.
To sum up, the problem is not on the U.S. hands, but on the U.S. debt holders’ hands. The U.S. could just let the dollar depreciate more, and more and more.