As many Americans may be aware, our national debt (vs. the deficit) is now over $22 Trillion – and continues to grow. How will the U.S. national debt be paid? Or will it be?
Politicians of both parties take their cues from the voters. And if the voters are interested in something, politicians usually follow. Unfortunately, the national debt is not something most voters are worried about – at least not yet.
As a quick recap, the national debt is simply the government’s debt that the government issues in the form of Treasury Notes and Bills (which even you can buy here) when the tax money being collected is not enough to pay for all of the things the government needs to pay for.
A pretty good analogy is a family who uses a credit card (debt) to buy things (or go out to eat) when they may not have the money to do so at the time.
And, just like the family with the credit card, the debt has interest that must be paid. In the government’s case, that interest has been very low due to low interest rates (which are, ironically or conveniently, also set by the government).
As interest rates rise, the interest on the national debt will also rise.
“Interest costs are expected to continue climbing beyond the next 10 years and are projected to be the third largest category in the federal budget by 2025 (after just Social Security and Medicare), the second largest category in 2035, and the single largest category before 2050.”
So what is the government to do? To lower the national debt would require one or two things (or doing both at the same time); raising taxes and/or reducing government programs. More than likely, any politician suggesting either of those two things will not get elected.
There would need to be a massive tax increase, some say anywhere from a 10-30% increase in everyone’s taxes – including the poor and the middle class, in order to begin to correct the problem.
And the increase in taxes would also need to include a freeze or reduction in government programs by about the same percentage.
Since neither of those two things, increased taxation or a reduction in government programs, is likely to happen, what might solve or greatly reduce the U.S. national debt problem? One word – inflation.
And how can inflation help reduce or eliminate the national debt? Easy. In periods of inflation, debt remains constant while revenues increase – all without a tax increase!
Let’s use an example to illustrate. John and Mary are a typical American family. They own a home (with a 30 year fixed mortgage) and 2 cars, which are both financed through the bank. They also have quite a bit of credit card debt, mostly from buying furniture for the new house and the trip to Hawaii last year. They are also in over their heads because their house, car and credit card payments are actually more than what they make in salary.
To make up this “deficit”, they are taking credit card cash advances, depositing the money and then paying the bills. This, of course, will only last until they reach their credit limit – though it’s a high limit, so this can continue for at least another 9 to 12 months.
But John and Mary are lucky. They are both in line to receive very large raises as they are valuable employees. With the increase in revenues, they will be now be able to pay the debt – which will no longer increase.
Using the above example for the U.S. government, inflation increases everyone’s wages and prices, so tax revenues will increase as well. Of course, for this plan to work, tax revenues would need to rise faster than the debt. John and Mary would make no progress on their debt if they used their raises to buy new things or continued to go into debt.
So, assuming the U.S. Federal government will continue to see spending increases of at least 3-4% per year, inflation (tax revenues) must increase greater than that (see Note 1). So how much inflation (or increase in tax revenues) would we need each year to really put a dent into the national debt?
Tax revenues for 2019 are estimated to be $3.422 Trillion. Expenditures are estimated to be almost $4.4 Trillion, for an over $1 Trillion deficit – a 28% difference.
So in this case, if one wanted to decrease the deficit (not the debt, just the deficit) in one year, one would need an inflation rate of 32% (current deficit of 28% plus the growth of spending of 4%). Of course this high a rate would probably not occur. But inflation of 10-15% has occurred in our recent past (see chart).
So let’s assume a 15% inflation rate for about 3 years, would take care of the deficit at a government growth rate of about 4% per year. (see Note 1)
But what about the debt? The national debt will be around $23 Trillion by 2020. At a rate of inflation of 15% per year, it would take about 50 years to eliminate the national debt – too long a period of time.
However, a short burst of very high over several years, would do the trick, though probably NOT hyperinflation.
Hyperinflation is defined as a runaway inflation rate of over 50% per month. This usually occurs in smaller economies, periods of war or extreme political instability. Hyperinflation will probably not happen in the United States.
However, an inflation rate in the 30-50% per year for a few years certainly might.
So my prediction?
When interest payments on government debt rise above the defense budget (2022) and then begin approaching 20-40% of the total U.S. budget (around 2024 – 2030), the Great Inflation will begin. From around 5-15% for a few years, then a burst of 30-50% for a few years – for there is no other way to solve the U.S. government debt problem.
My advice as to what to do? That is a topic for another future blog post.
Note 1: Tax revenues also increase with an increase in the economy and/or tax increases. Tax revenues can also decrease due to a recession or a tax cut. For our purposes, we are assuming these other reasons net each other out to zero and the only true increase in tax revenues is due to inflation.
However, the 2018 Tax Bill included a sneaky little present for taxpayers. Read about it here.
Note 2: Many government programs, such as Social Security are, in theory, tied to inflation. In other words, when inflation goes up, SSI payments go up the same percentage. Or do they? Though they do increase, they do not keep up with inflation. Read about that here.