The Debt Problem Hasn’t Vanished

Quoted today from the WSJ (full article here):

As the debt burden rises, so too does the cost of servicing the debt increase as a share of the growth the economy is capable of generating. When the debt on which interest is paid equals the GDP level of a nation, the economy must grow faster than the interest rate to avoid debt-servicing costs consuming all the benefit of economic growth. A nation then begins to lose its ability to grow its way out of a mounting debt crisis. Its options start to narrow down to forced austerity, inflation or default.

Today the total U.S. federal debt is 103% of GDP. Since interest paid to the Fed, the Social Security system and other government pension funds is effectively rebated to the Treasury, taxpayers currently bear only the burden of interest on 60% of this debt. But the size of the debt and the percentage of the debt on which interest will have to be paid are rising.

The president and many in Washington are complacent because, thanks to the Fed’s unprecedented near-zero interest rate policy, the burden of servicing the debt today is just 0.9% of GDP, the lowest level in over five decades. But this cannot last, and the Fed is already looking for an exit plan.

Sadly, nations generally discover the truth of Albert Einstein’s dictum that compound interest is the most powerful force in the universe—not through the happy accumulation of wealth but through the agonizing enslavement of debt.

This is why the debt-to-GDP ratio is the important one to watch. The following excerpt is from Common Cent$: A Citizen’s Survival Guide

The overall debt limit is a distraction—uncomfortable perhaps, but still a distraction. Instead, we need to consider the long–term consequences of excess debt on the productive capacity of the U.S. and world economy. This is better measured by the ratio of total debt to GDP. In addition, we can measure the short-term trend with the ratio of the annual deficit to GDP. This ratio shows whether our spending is having the positive effect of increasing our incomes, wealth, and standard of living, or merely impoverishing us in the long term.