The U.S. Is in a Precarious Financial Situation
Tim Hayes, CRPS®, AIF®, AWMA®, CFS™, CTS™, CES™, APMA®, CAS®
You would think that with the stock market at an all-time high and interest rates at exceptionally low levels, the United States must have its financial house in order. Nothing, however, could be further from the truth.
Exploding Public Debt and Deficits
When President Reagan took office, the federal public debt ratio to Gross Domestic Product (GDP) was around 31%. When he left office, it was about 50%.[i] Today, after the 2008 Great Recession and the COVID-19 pandemic, with total government debt around $27 trillion and a $21.5 trillion GDP, the debt ratio stands at 129%. The previous high of 118% occurred at the end of the Second World War.[ii]
Today, the deficit hovers around 14% of the GDP. The only time it was higher was also at the end of WWII when it reached 27%. Amazingly, it took only four years 1948 until the U.S. government turned this deficit into a surplus.[iii]
Read More: Does the U.S. Still Have a Debt Problem?
Near-Record Private Debt
With a GDP of $21.5 trillion, private debt today—which includes mortgages, car loans, and business debts—is about $34 trillion, making the ratio of private debt to GDP 160%. Before the Great Depression, it was 140%, and right before the 2008 Great Recession, it got as high as 170%.[iv]
Gigantic Total Debt
In 1980, total debt—private, corporate, state, and federal—was 1.75 times the GDP. Today, it is around 3.8 times. Think of it this way: in 1980, we had $175,000 of debt for every $100,000 of GDP. Today $100,000 of GDP equates to $380,000 of debt.
In raw numbers, total debt in 2008 was $50 trillion. Today, twelve years later, it is at $80 trillion.[v]
An Enormous Federal Reserve Balance Sheet
The Federal Reserve’s balance sheet is currently $7.4 trillion, which equates to 35% of the GDP, eclipsing the previous high of 23% of the GDP during the Great Depression and 20% at the end of WWII.[vi]
And after ten years of quantitative easing, the Federal Reserve now owns 22% of outstanding Treasuries, 5% higher than the previous high of 17% in 1974.[vii]
Can We Grow Our Way Out?
With President Biden’s $1.9 trillion COVID-19 relief package and, my guess, another aimed at infrastructure, the administration hopes that the economy can outgrow its current debt levels similar to post-WWII.
However, the level of private debt is more significant now. During the war, the government limited personal debt, requiring large down payments on installment loans and restricting terms to one year.[viii] Plus, the depression forced untold bankruptcies and the write-off of enormous personal and business debt.
So, after the war, consumer and business spending quickly made up for any reduction in government outlays. But unlike then, there is more competition for economic success because the rest of the world does not lie in ruin from the war.
Should You Make Any Changes to Your Financial Plan?
As bad as these debt levels are, they are not predictive. Keep your allocation between stocks and bonds that meet your goals and risk tolerance. Don’t chase rising stock prices. Resist the drumbeat of inflation predictions. Diversify some outside of the United States. Maybe lock in any variable rate loans. If possible, pay down some debt.
These are the opinions of financial advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice.
[ii] Amadeo, Kimberly, “ US National Debt by Year Compared to GDP and Major Event,” the balance, February 5, 2021, https://www.thebalance.com/national-debt-by-year-compared-to-gdp-and-major-events-3306287
[iii] Amadeo, Kimberly, “ US Budget Deficit by Year Compared to GDP Debt Increase, and Events,” the balance, October 8 2020, https://www.thebalance.com/us-deficit-by-year-3306306
[iv] Perkis, David F, “ Making Sense of Private Debt,” Economic Research Federal Reserve Bank of St. Louis, March 2020, https://research.stlouisfed.org/publications/page1-econ/2020/03/02/making-sense-of-private-debt
[vi] Christopher J. Waller, Lowell R. Ricketts, “ The Rise and (Eventual) Fall in the Fed’s Balance Sheet,” Federal Reserve Bank of St. Louis, January 1, 2014, https://www.stlouisfed.org/publications/regional-economist/january-2014/the-rise-and-eventual-fall-in-the-feds-balance-sheet
[viii] Richardson, Gary, “Federal Reserve’s Role During WWII,” Federal Reserve History, https://www.federalreservehistory.org/essays/feds-role-during-wwii#:~:text=The%20Reserve%20Banks%20processed%20applications,postwar%20return%20to%20peacetime%20activities.