The U.S. reached an important but unpleasant milestone in 2014. For the first time since 1947, America's national debt exceeded our gross national product (GDP). Using data from Q3 of 2014 (end of fiscal year), the national debt reached $17.824 trillion. The corresponding $17.6 trillion GDP yields a debt-to-GDP ratio of 101%.
GDP measures the total economic value of all the goods and services produced by the country over a given period, while the debt is a snapshot value at any point in time. For accuracy in calculating a debt-to-GDP ratio, it is important that the time values match.
Is a debt-to-GDP ratio over 100% something to be concerned about? It is not inherently bad to have greater debt than GDP if the debt is being used constructively to stimulate the economy. However, in this case, it may be an indicator of more disturbing trends.
Consider how the debt-to-GDP ratio is calculated. The debt can be reported in two different ways — public debt and total debt. GDP ratios often use total debt (as we do in this article), but some sources such as the CIA World Factbook use public debt. Public debt includes all the governmental issues (treasury notes and savings bonds) that are held by pension funds, mutual funds, companies, other governments (U.S. local governments and foreign countries), and individuals. The non-public debt is on the books as intragovernmental holdings – essentially money the government owes to other parts of the government.
Some sources argue that intragovernmental holdings are simply accounting transfers, and do not really matter in the overall ability to repay debt. However, in the case of the U.S., the intragovernmental holdings are mostly borrowed from the Trust Fund for Social Security and Federal government retirement funds.
Essentially the "lock box" for Social Security contains a big box of IOUs. When the Baby Boomer generation retires, the Social Security Administration will have to cash in holdings to pay benefits. Thus intragovernmental holdings is not debt the government owes to itself, it is debt that is owed to the American people — a different form of public debt, and one where the funds have been spent ahead of future obligations (arguably a form of credit).
That is why the current debt-to-GDP ratio is troubling. The last time the debt-to-GDP ratio exceeded 100%, it was in the aftermath of World War II, as the massive war spending ramped down and debt had to be bled down. To put that in perspective, in 1942 prior to involvement in the war, the debt-to-GDP ratio was at 44%, the debt was $72 billion and the GDP was $166 billion. The war cost $296 billion by itself, leaving 1945 debt-to-GDP at 116% (still the highest in U.S. modern history), with $259 billion in debt and only $228 billion in GDP.
Debt-to-GDP ratio dropped below 100% in 1948 (90%) and continued a relatively slow decline to reach the mid-to-low 30% range in the mid-1960s. It maintained this range through the early 1980s. At that point, the debt-to-GDP ratio rose to a plateau in the 50%-70% range, where it stayed until the 2008 fiscal crisis.
Since 2010, the GDP jumped up to a new plateau in the 90% range and has begun a slow rise since then. The primary reasons are the increases in spending for the continued war(s) on terror and economic stimulus programs, with relatively little economic return to show for it. Instead of the large and nearly catastrophic events of WWII, the current situation is slowly approaching the same levels of debt-to-GDP without a single major triggering event or an endpoint to curb spending or allow debt reduction (like a traditional war).
Sluggish economic growth has kept the ratio out of whack — and with looming commitments to the Baby Boomer generation and no obvious strong growth in sight, deficit hawks are concerned that we are not receiving value for our spending dollar. They contend that we could soon reach a point where so much money will be necessary to service interest on the debt that draconian spending measures will be necessary in the future, initiating a downward economic spiral.
Spending must bring value for the dollar and taxes must be delicately balanced to bring in sufficient funds without stalling the economy. Otherwise, the deficit hawks will be proven right.