Is The Growing U.S. Debt Sustainable? Not Indefinitely, But Don't Ring The Alarm Just Yet

Figure 1: Debt to GDP

Debt to GDP

Source: Refinitiv DataStream, Russell Investments, as of 1Q2020. Click image to enlarge.

Getting back to federal debt, Figure 1 shows U.S. sovereign debt has steadily increased since the GFC. But, the pace has now accelerated due to historic fiscal support in response to the COVID-19 pandemic. U.S. debt-to-GDP at 110% has crossed the psychologically important 100% level. While U.S. deficits have recovered from such levels in the past, notably after World War II, the COVID crisis brings its own unique challenges.

Therefore, the operative question is: Is the current pace of debt accumulation sustainable?

The short answer is no, but the actual answer is a bit nuanced. Fiscal profligacy cannot be sustained indefinitely, and fiscal discipline is necessary at some point. Nonetheless, when the forecast calls for rising flood waters, the objective is reinforcement. The rebuild comes later. Similarly, fiscal policy now is focused on containing the damage brought on by the pandemic. Only once the storm passes can the focus shift to rebuilding.

Rebuilding starts with stabilizing the debt-to-GDP (D/GDP) ratio. So, let’s first break down both components of that ratio in order to gain a better understanding of the moving parts.

  1. Debt: There are two principal components to consider here. The aggregate debt outstanding and the cost of servicing the debt. Debt outstanding will rise during recessions due to rising deficits as the economy stalls and federal support ramps up. Meanwhile the interest expense, which is the cost of servicing debt, is influenced by the past and prevailing rate of interest.
  2. GDP: Gross domestic product is the total output the economy produces. The GDP contracts during recessions and expands once the recovery commences.

Looking ahead, it’s important to consider the trajectory of the D/GDP ratio over multiple time horizons. Over the immediate timeframe, it’s reasonable to expect it to rise further, as the government runs large deficits to offset the demand shock due to the pandemic. Over the medium to longer term, however, the focus shifts towards its stabilization.

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