Elections and National Debt | Joao Gomes

Why Is the National Debt an Urgent Issue?

Dan Loney: Currently, the national debt is around $30 trillion. The debt-to-GDP ratio is closing in on 100% and continues to grow. And we just surpassed a plateau where the interest payments on incurred debt is about $1 trillion a year. Obviously, debt is a significant issue, yet the candidates for president aren’t talking about it a lot.

We’re joined by Wharton finance professor Joao Gomes, who testified earlier this year in front of Congress about the issues around the debt. Joao, seeing the debt rise in the manner that it has, what are the larger-scale impacts that we are potentially looking at in the relatively near future?

Joao Gomes: The relatively near future is a little hard to say. I think it is progressively recent. My favorite analogy is that it’s a bit like gaining weight. You go to your doctor, and you look at the data, and he says, “You know, you’re getting a little bit heavier. Why don’t you do something about it?” And you say, “Well, I’ll do something about it in two years, in five years, in 10 years, and I’ll be fine.” You’re probably, sort of, kind of fine, but you never know. But at some point you’re not fine anymore. And I’m fairly sure that day will come, right? Whether it’s five years from now, 10 years from now, or next year. I can’t be sure. But the probabilities that you’re going to get in trouble are going up all the time.

I’m not super-worried about the debt right now. I am really worried about where it’s going to go, where it’s projected to go. And the fact that the politicians don’t seem to care one bit. Left or right, they just plan to spend more. That, I’m really worried about.

Loney: Take us into your testimony before Congress back in March.

Gomes: That was a very specific hearing on climate change and fiscal policies that support it, or a number of measures to address climate change. The point that I tried to make there was that I see the debt problem as bigger and more urgent than the climate challenge. It will come earlier. We will face a fiscal crisis in the next 10 or 15 years. Ten will be almost the outer bound that I would put on that, and when it happens, it will touch all of us. I really mean all of us — every part of the economy, from the banking system and our bank deposits to our paychecks, to Social Security and Medicare. There will be damaged mortgages across the whole economy. The value of the dollar. I think that a more urgent and more pressing concern, and I think the way we think about some of these longer-term challenges — not to minimize it. They are really important, but there is only so much money we can spend addressing them, without thinking, “Well, that’s going to create a much bigger problem in the short term.”

Loney: What type of approach do we need to at least start to get that train rolling down the tracks?

Gomes: I think we need first to not make any really silly mistakes. I think a lot of times, a debt crisis happens because a particular set of politicians, I’m going to say, but that would include a chair of the Federal Reserve, just loses the trust of financial markets. They propose a certain set of policies or put forward some types of ideas that just make people wake up to the sense that, “This is just not working. This is just not somebody I can trust with $2 trillion dollars more this year.” I think that’s important, but I think people need to think about how we pay for some of these proposals that we make.

Whether you’re on the left or the right on this, it doesn’t really matter. Both candidates are, at this point, incredibly populist in the sorts of things they put forward. And none of them has a plan to pay for any of this. At a minimum, we need that fiscal discipline, that sense that, “OK, I want to accomplish X,” but be honest with the citizens of this country and say, “I need to pay for it, and I need X or X-plus-something to cover those costs.” Until we do that, I think we live in this pretend world that we can just borrow more and more and more, and for a while we can continue to gain weight. We can continue to overeat. But the penalty is going to be severe, and the question is just which generation and at which point? And which political party is going to be in power when it happens?

Loney: You talk about the potential of a financial crisis. To what extent are we talking about it? In multiples beyond what we saw in 2008?

Gomes: Oh, I think so. I absolutely think so. In fact, it could work in reverse. One of the things we saw both in 2008 and 2020 with COVID was both of those episodes were something that didn’t have anything directly to do with the government. It was not a fiscal crisis with the treasury. But the economic crisis that unfolded — the debt might have gone up 15% to 20% of GDP in both episodes because the government felt a need to send stimulus checks, to bail out banks, to do various types of things. So, it could work that way. But if it is a pure fiscal crisis, in the sense that folks wake up one morning and say, “We just don’t have confidence in the U.S. government anymore,” we will have a serious economic crisis on our hands. In that scenario, we might have to tighten our belts by the equivalent of $2 trillion. Just think about the spending cuts that that entails and the damage that would do to the economy.

I think it’s a very scary, and I’m an optimist by nature. I continue to hope that we will find our way out of this. But if that scenario unfolds, it is a very scary scenario.

Loney: And a variety of programs, like Medicare, Social Security, all of these would have to take a significant haircut in order to be able to keep going.

Gomes: A real possibility. Another possibility is a very sharp increase in taxes to cover a deficit of $1 trillion or $2 trillion. It’s taxes on everyone. We would have a substantial tax increase on every single person. It can’t just be concentrated on the top 1% or 2%. There’s just not enough revenue there. It would be an adjustment that I think we don’t want to go through. And to be fair, that’s the reason no candidate right now has a huge incentive to do much about it, unfortunately.

Loney: Just kick the can down the road more.

Gomes: Just kick the can down the road and hope the next person will take care of it.

Possible Solutions to the National Debt

Loney: In reading your notes on your speech before Congress, there’s an interesting note about how the debt could have the potential to be more stubborn in terms of our population, using that as an example. Our aging population could actually help us prevent growth in the country.

Gomes: Oh, it does currently. The best scenario we can hope for to get out of this is, and I think it should be an obsession for us economists, policymakers, and so on, is how can we grow our tax base? We have an aging population. We want to take care of them, and cutting benefits there is going to be difficult. Let’s just accept this as a challenge. The only way out of this is to have a bigger tax base, to increase the revenues for the government. The best scenario there is to increase the size of the pie. That’s the best scenario we can hope for.

So, things like more people, more people in the workforce, people working longer, more productivity, more entrepreneurship — those things should be basic priorities for us. That’s the one hope that we have, and we have to still have a significant amount of growth. Absent that, the demographic pressures make our problems incredible, very, very challenging in the past 10 years or so. The Social Security Trust Fund runs out in 2033. That’s the latest that I would envision this conversation taking place. At that point, it’s not a conversation for bankers, for hedge funds, for fund managers. It’s a conversation for 50 million people who are going to think about, “What happens to my check?” We may have that conversation earlier, but I think no more than 10 years from now.

Loney: You also have to factor in is the interest in buying off the debt by other countries around the globe, and some of the relationships that you have or don’t have with some of these countries that are used to buying the debt. How that could factor against us, as well.

Gomes: Exactly. That’s a really good point. Talking about America becoming self-sufficient also means we become self-sufficient in terms that we can fund our debt ourselves, or increasingly more. That is challenging. Right now, 40% of the U.S. debt ultimately placed in the balance sheets of different agencies in different countries. Becoming self-sufficient forces U.S. consumers, U.S. businesses to buy more of that debt, for the U.S. banks to do it. If I force you to buy paper, because that’s what I’m doing, you cannot use the money to turn around and eat, buy a house, go shopping, take care of your kids. It could be really challenging in an environment in which we want to become a little bit more close, a little more self-reliant. It will be a lot more challenging to fund this government without imposing significant penalties on our standard of living.

Loney: Take a moment and talk about the importance of having these countries buy that debt and what it has meant for our economy in the last many years.

Gomes: Lower rates and more money. Lower interest rates. Lower mortgage rates for the average person in the U.S. That’s just it. There is just more money coming in, and as a result, banks don’t need to buy government debt. They can turn around and provide mortgages at cheaper rates. That’s probably the most common thing they do. It’s not the only thing they do, but that’s really the most common thing they do. It has been really valuable to us that in various parts of the world. People there have just saved a lot, and they view U.S. government debt and the dollar as a place to really store their wealth. They prefer to do that than buy local houses, than invest in the local stock market, than to start a business there. They just have that enormous trust in our federal government. And the moment they don’t, our federal government loses one very reliable, cheap source of funds and is going to have to replace that in some other way. Or it’s going to have to be cut.

Loney: Your comments that you made in front of Congress — have you heard back? Have they resonated?

Gomes: I hope they’ve resonated. We will see. I’ve heard back. We’ve had some interactions. I knew this going into that conversation going into the election. You just see the themes right now are really, “What can we propose that makes people feel like my administration is going to do more for them?” They’re not really interested in a conversation about that. Nobody is. I think that conversation will be scary, will be difficult, would be uncomfortable with raised concerns about, “Which taxes need to go up?” Nobody wants to have that conversation right now.

I think either that conversation is going to be forced on the next administration, or there will be some luminaries there that actually have a forward-looking attitude and think this is something that we want to think proactively about, and we want to address it. I was surprised how aware people are of the problem. They’re just not willing to tackle it.

Loney: What’s unique is the dynamic that we have on Capitol Hill with our political system right now, and the division that we have. It doesn’t even matter that this really is a solution that would require both parties, that neither is even calling the other out about the problem.

Gomes: I think that’s exactly right. Neither one is, and both of them are very comfortable in this world of, “OK, I’ll see your $2 trillion, and I’ll raise you two more.” It’s going to be something we deal with in the future. It’s very unfortunate. I don’t know exactly how we got here, but I know it could end in an instant. The U.K. in 2022, and I know people always say the U.S. is not the U.K., and so on, but this could end in an instant. This could end very quickly and very painfully.