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business newsCan the US Pay Back Its Debts?
By
James Kostohryz
May 12, 2010 9:00 am
The most important thing to understand about the question of paying down debt is that it's irrelevant.
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So let’s address this question head on: Can the US pay back its debts?
If this question is directed at determining whether the US could ever pay off all of its current debt, eventually bringing its net debt balance to zero, then the answer is yes. But the most important thing to understand about this question is that it’s irrelevant.
If the question is directed at inquiring whether the US can meet interest and principal payments on its sovereign obligations, then the answer is that it can do so easily for the foreseeable future.
Could the US Bring Its Debt to Zero?
Let’s first objectively address the claim, made quite frequently in the financial media, that the US’s current level of debt simply cannot be paid. Specifically, let’s examine whether or not the US could bring its debt down to zero
First of all, in real terms, the projected interest burden on the current level of US debt is extremely low. For example, if one assumes inflation of 2.5% and average blended nominal interest rates of 3.5% on the debt (includes rates all along the curve), the interest burden as a percent of GDP amounts to about 0.5% of its current GDP. Obviously, since GDP grows over time, this burden amounts to even less as a percent of future GDP. Thus, the fact that the US can easily handle its interest burden is undeniable.
But what about principal payments? Once one realizes that interest payments constitute a minor portion of GDP, it becomes clear that paying down the principal of that debt would theoretically be possible. For example, let’s assume that the US economy grew at an average nominal rate of 5% -- 2.5% real growth and 2.5% inflation. Under such circumstances, even if the US only devoted 1% of its annual GDP toward paying down its net debt every year, US public debt would reach zero in roughly 27 years.
Below I include the calculations for those that are skeptical. The figures are exact as of March 31, 2010, which corresponds to the last date for which we have a GDP figure.
That’s the math. The rest is simply hot air.
Now, let me be clear that the figures provided aren’t meant to be projections. This exercise was meant to illustrate mathematically how the US could pay off its debt. You can play with the assumptions all you want. For example, one could assume that debt will increase for the next seven years before the budget is brought into balance and apply a principle drawdown from that point. That would extend the number of years it would take to pay down the debt. One could also bump up the real growth rate, the inflation rate, or the pay-down rate, all of which would reduce the number of years needed to bring down the debt to zero.
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