Can The U.S. Government Go Bankrupt?

Can The U.S. Government Go Bankrupt?

According to Time Magazine, the answer is yes. I refer to their recent cover proclaiming “Make America Solvent Again!” and touting our current $13.9 trillion debt level.  Sounds more like a rallying cry for a political candidate than an attempt to educate the public on economics.  But that’s pretty typical for the media these days.  And this blog is not about media-bashing, although it’s hard to restrain myself from slipping into that habit since they make it so easy.  Rather, let’s take their statement at face value and explore how much of a problem the federal debt really is.

The first question is which economic theory should you apply? There are as many theories as there are economists (if not more).  You can find those that argue we need to reduce our debt level as well as those that tell us it doesn’t matter.  Since the latter is probably harder to comprehend, I’ll start there.  One theory representing the “no problem” side is Modern Monetary Theory (MMT), promoted by Randy Wray and Stephanie Kelton, economics professors at the University of Missouri.  Simply put, since the federal government is able to create its own money, it has an unlimited capacity to pay for whatever it wishes to purchase and to fulfill promised future payments.  Therefore, it is not possible for the U.S. government to become insolvent or to go bankrupt.

If you think about this for a while, it makes sense. But if so, why does the government need to tax us?  And why do they need to sell or buy government bonds?  According to the theory, taxation and the power to discharge debt is what establishes the U.S. dollar as a real currency, giving it value by creating demand for it in the form of private tax obligations and manipulating its supply through bond issuance and repurchasing.  Put another way, the level of taxation relative to government spending deficits or surpluses is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.

Wow! This is way beyond Economics 101. Although I’m not quite ready to throw my support behind it, it is certainly a very interesting way of looking at federal debt other than as a huge drain on our country’s productivity.  And it completely repudiates the Time Magazine headline.

But perhaps the economic model is too difficult to digest. OK, let’s look at our country’s debt from another angle.  Just about everyone complaining about the level of U.S. government debt compares it to GDP.  According to the Federal Reserve Bank of St. Louis, that number currently stands at 104%.  Many economists have argued that when this ratio exceeds 100%, it creates an out of control spiral leading to economic chaos.  Well, Japan’s debt to GDP ratio has been well over 200% for quite a number of years and they haven’t collapsed yet.

But more importantly, I don’t see the point of this ratio in the first place. Suppose you are a family living in Northern California with an annual income of $100,000 and carrying a $300,000 mortgage on a $1 million house.  Under those circumstances you’re probably living reasonably comfortably.  Yet your debt to income ratio (which is analogous to debt to GDP for the government) is 300%.  Should you be preparing for bankruptcy?  I don’t think so.

A more reasonable evaluation of the size of the federal debt ought to include a comparison to the government’s asset base. This is the other side of the balance sheet and is Accounting 101 for public companies.  The government does not calculate or report such data, and I’ve been unable to find any definitive valuation.  Cullen Roche, the Founder of Orcam Financial Group, took a stab at it, citing an article from the nonprofit Institute for Energy Research in 2013 that estimated the value of total fossil fuel resources owned by the federal government at over $150 trillion alone (perhaps a bit less at today’s prices). That’s at least ten times the national debt.  And if you add in all the government-owned real property above ground and other assets below ground or in vaults such as gold, he suggests the figure is closer to $200 trillion.  If correct, that would be the equivalent of our Northern California homeowner holding less than $70,000 worth of debt on his $1 million home.  Where’s the problem?

I’m not suggesting that there won’t be consequences from higher and higher amounts of government debt. Inflation or even hyper-inflation is one possible negative outcome.  There’s also the potential for one country’s high debt to impact global currency movements, the ramifications of which I do not comprehend.  But insolvency?  That’s a stretch.  I wouldn’t run out and sell all your U.S. Treasury bonds just yet.

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