I don’t know, but here are the principles involved.
Last time I reported on my investigation of the US national debt, which recently passed $40 trillion. I’ve no idea what a trillion means, so I thought of the US like an individual, with a national income equal to the US Gross Domestic Product (GDP), and an unsecured interest-only mortgage equal to total government debt (that’s the $40 trillion). Every year this individual makes interest payments on that debt; and those interest payments have shown an increasing trend.
There’s an obvious question: at what point does the ratio of interest payments to income become worrying? I don’t know. A dear and very erudite friend laid out, for me, the principles that are involved.
Let’s see what can keep the size of the debt under control.
The obvious first pathway is the government’s annual operating surplus or deficit: that’s what makes the debt decline (if there’s a surplus) or grow (if there’s a deficit). This is actually something the government can control. It can raise taxes or cut spending (or do both), if it wants to reduce the deficit. But that’s not popular with the public, so it’s not popular among politicians.
OK, then, instead of a budget that projects a surplus, let’s next consider a balanced budget. Then the debt/GDP ratio grows if the rate of interest payable exceeds the growth in GDP (i>g, as mathematicians would symbolize it), and falls if growth exceeds the rate of interest payable (g>i).
Yes, governments are optimistic when they predict g and i! But in reality there aren’t many examples in our lifetimes when g exceeds i. The Clinton years, as I mentioned last time. And after World War 2, when rapid productivity growth combined with the Baby Boom population growth dramatically reduced the size of government debt. That ended in 1974. And “real” interest rates (that is, the excess of interest rates over inflation) were low (or even occasionally negative) because buying government debt was viewed more as an act of patriotism than as an excellent investment.
(Side observation: Our grandparents’ generation got screwed, as far as investing is concerned. World War 1, then the Depression, then World War 2, followed by the low interest rates and high inflation.)
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What about today?
Fertility rates are below what’s required for long-term population and GDP growth, so we need improvements in productivity and keeping interest rates low.
Are these likely?
Well, this isn’t a generation used to enduring hardship. So the government needs to offer them high interest rates. So the only solution is high increases in productivity, otherwise there’s no control.
Oh wait, can’t we increase the population? Immigration doesn’t do much, and isn’t popular among the country’s residents. That means: more children, that is, an increasing fertility rate. As I said, it’s not happening.
OK, then, rapid productivity growth? If we can, sure. But …if it leads to fewer jobs rather than simply higher GDP then we face other problems.
So, which path for the future? Obviously we can’t predict what’s going to happen. One can think, cynically, that any government is likely to pursue the path of promising the most while doing the least – whatever shape that may take in the ruling circumstances. We know the desirable goals, but not the policies!
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All of which suggests to me that it’s tough to see improving times ahead.
But that doesn’t answer the question I posed at the outset: at what point will the ratio of interest payments to GDP become worrying?
My answer is: I just don’t know what’s the turning point.
Sorry.
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Takeaway
Thinking about the factors and actions that can stop the ratio of government interest payments to GDP from increasing, I’m not hopeful. But I’ve no idea when investors will get really worried about it.
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I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.