“In national politics, we can expect an emergency that requires borrowing. Public dangers, especially financing in the event of a foreign war, proved to be an indispensable resource, even to the wealthiest. . . it is imperative that national credit be well established . . The secretary is confident that proper financing of the current debt will be a blessing to the nation. ‘Public debt is a public good, a position that invites debauchery and is vulnerable to dangerous abuse, and he aspires to see it incorporated into the U.S. public credit system as a basic maxim. The creation of debt should always be accompanied by means of extinguishing it. (emphasis added)” — Alexander HamiltonFirst Report on Public Credit“
The US will reach its $31.4 trillion debt ceiling on January 19, 2023. This is just above the limit Congress approved two years ago. The US Treasury Department is now taking very urgent steps to prevent the country from defaulting on its debts.
The current battle over the debt ceiling reveals the painful reality that nations must face. He has two key principles in this matter, and Alexander his Hamilton refers to both in the quote above. First, maintaining US creditworthiness is essential to the health of the US economy. Voluntarily defaulting on federal debt would jeopardize the very foundation of the nation’s economic success. Second, the current course of unsustainable budget deficits could lead to similarly catastrophic involuntary defaults in the years to come.
These uncomfortable truths have several important implications.
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1. Public debt is not what it used to be
In 1790, the survival of the United States was uncertain. The country won the War of Independence and ratified the Constitution, but its finances were in chaos. State and federal governments could not repay their war debts, or even pay their veterans. This has affected the performance of the country’s economy and the government’s ability to regulate it. But Hamilton, the first Secretary of the Treasury, understood the vital role that a country’s credit integrity would play in ensuring economic prosperity. He coordinated the passage of several regulations that would restore the country’s creditworthiness.These programs include the consolidation of war debts under the federal government, a system of tariffs to fund the payment of outstanding debts, and Creation of a central bank.
Without these measures, the United States may not have been financially able to withstand the “emergency” Hamilton referred to. Adherence to Hamilton’s financial principles enabled the United States to survive his War of 1812, the Civil War, and World War I.
When these emergencies ended, the country followed Hamilton’s Second Principle and ran a federal budget surplus to extinguish the debt. But that changed after World War II. Initially, the United States paid off its debt as before, but by the 1960s a permanent peacetime deficit became the norm. According to his 2022 estimates from the Congressional Budget Office (CBO), the trend is expected to continue over the next decade, resulting in a deficit of his 5% of average annual GDP. Sustaining such a trajectory indefinitely is not possible, but aging populations and long-term declines in productivity threaten to exacerbate the problem beyond 2032.
US federal budget deficit as a percentage of GDP, 1791 to 2022
![Chart showing the percentage of the US federal budget deficit to GDP from 1791 to 2022](https://i1.wp.com/blogs.cfainstitute.org/investor/files/2023/01/US-Federal-Budget-Deficit-as-a-Percentage-of-GDP.png?resize=640%2C385)
Why did the US change its philosophical approach to public credit? One reason is simply that it could. Since the Bretton Woods Accords of 1945, the US dollar has become the world’s reserve currency, and US Treasuries have become a vital store of value for central banks and savers around the world. Massive expansion of the entitlement program also played a role. This is not a political decision. These programs have real social benefits, but the corresponding costs are beyond the country’s funding capacity. According to the Congressional Budget Office (CBO), Social Security and health care programs such as Medicare and Medicaid make up the majority of the federal budget. By 2032, they will be well over 50%, and their costs will only increase as the population ages.
2. Don’t make the cure worse than the disease
The United States cannot build up debt faster than the U.S. economy grows forever. But it can be quite long. Therefore, refusing to raise your debt limit and going into default is unenforced self-harm. At the height of the 2008 Global Financial Crisis (GFC), Congress initially rejected the Troubled Asset Relief Program (TARP). The bill passed on the second ballot, and TARP helped restore confidence in the US financial system. Who knows what would have happened if the second attempt failed, but it would have been disastrous.
The same is true for debt ceilings. The United States has never defaulted on its public debt, so the outcome is unpredictable. But they will be tough. The possibility of default in the more distant future is a risk that must be addressed, but a voluntary default would have the same economic impact as driving off a cliff instead of running out of gas.
Disadvantages of a divided nation
Political division in the United States is at a cyclical high, but it is getting worse. After all, the country went to war in her 1861. Nonetheless, threats to US financial stability require a concerted effort. The longer unsustainable debt build-up persists, the more severe the consequences, and ultimately the tougher action required. It may not be wise to voluntarily default in 2023, but it will leave future generations with a debt that they cannot pay or require a drastic reduction in their standard of living to pay off. It is equally irresponsible to impose.
Through wars, panics, recessions, pandemics, and natural disasters, America has always succeeded in bringing divided people together to meet these threats. This unity has been passive at times, and the degree of sacrifice has been disproportionately distributed, but has always achieved the overall desired end.
The decline and collapse of great powers throughout history proves that there is no guarantee that the next existential crisis facing the United States will not be the last. Solving debt problems is painful and requires sacrifice. Only time will tell if the United States rises to the challenge or succumbs to decay like so many empires before it.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
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