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America’s national debt stole early August headlines when US credit ratings agency Fitch downgraded long-term US debt a notch from a perfect AAA to AA+.
The downgrade sparked fears of an alleged US “debt bomb” – a theoretical “vicious cycle” of borrowing to service debt, which would subsequently drive interest rates higher, forcing more borrowing and eventually inducing deep recession.
Meanwhile, many say US debt-to-GDP is even higher than Britain’s: 118.6pc as of the first quarter of 2023. With trillion-dollar deficits flying left and right, Fitch expects government spending to keep ballooning. It claims US debt is getting unwieldy with rising interest costs – whilst also citing political acrimony in its downgrade.
Wrong! Despite all these widespread fears, UK and US debt are both quite manageable. Take endlessly fretted debt-to-GDP: while America’s 118.6pc is relatively high historically, it is down substantially from Q2 2020’s 134.8pc. And this figure is gross debt, meaning it includes debt the government owns itself.
As an asset and liability, that debt cancels. Exclude it and the ratio falls to 93.2pc – a comparable figure to the UK’s 100.1pc. As for Britain’s debt load, it draws abundant headlines. But it basically matches levels since March 2021.
Regardless, debt-to-GDP comparisons are a balance sheet versus cash flow mismatch. Debt accumulates over time, while GDP measures a year’s economic activity. The more correct but less used metric is the annual tax revenue versus yearly interest payments.
UK inflation raises debt costs – but it also raises government revenue. How? VAT revenue rises alongside prices, while higher inflation-driven wages create a larger income tax base, due to the British government freezing tax bands amidst inflation. Higher interest rates do the same.
Boo for you, but all of this boosts tax revenue making debt more affordable than debt-to-GDP comparisons imply. A growing economy, even if that growth is sluggish, boosts tax revenue similarly.
Today, US interest payments’ share of tax receipts is lower than in the 1980s and 1990s. UK interest payments’ share of revenue has been rocky lately but remains below the 1980s (monthly data show the rise rolling over recently, too). Both nations’ stock markets did great in those eras – why should debt hamper them now?
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