By the Numbers

Why the Federal Debt Matters

Overloading the federal budget with more debt could trigger another recession. (Courtesy graphic)

Uncle Sam isn't much different than any other borrower overloaded with debt and limited income for repayment.

Constructive debt can be taken on that matches the repayment requirements to the income and cash generation timing of the entity (business or government). However, taking on additional debt to solve an income problem is often just delaying the eventual default. Brief cyclical downturns might be the only exception.

This was true of the Farm Financial Crisis in the 1980s, when the federal government allowed the Farmers Home Administration and the Small Business Administration to make direct or guaranteed loans when lenders had reached their limit. Asset values continued to climb when income didn't support it and when the crash did come, asset value and debt levels were higher and the crash more severe than if the market had been allowed to work.

It is an economic reality that supply and demand responses in input and output markets are always working to move the return to the average producer to breakeven. At that point, the best managers are still making money. The average producers are just hanging in there and the weaker ones are losing money and being forced out. It may be cruel and impersonal, but it is how the industry becomes more efficient and managed in a more businesslike manner.

The problem with the government continually taking on more debt without consideration for repayment ability is that politicians are just putting the problem off so that the consequences don't happen while they are in office. Remember, a politician's first priority is to get elected and his/her second is to get re-elected. They realize that for the most part, the public is naive enough or ignorant enough to blame those who are in office when the defaults occur. This has been the approach taken by Congress and the current administration when federal debt increased from $10 trillion in 2008 to nearly $20 trillion in 2016. Whether Trump or Clinton had been elected, there is a high likelihood of a major economic recession in the next four years. The Fed has simply run out of bullets. Following QE1, QE2 and QE3, and near zero interest rates, the options are inflation or bond defaults.

The problem is compounded by the fact that the European Union's and Japan's economies are in even worse shape. Nearly every country in the southern tier of the EU has a federal debt level that exceeds its GOP and in Japan's case, it is almost two and a half times. Although their economies are stronger, even long considered financial safe havens like Germany and Switzerland are issuing 10-year bonds at negative interest rates. The alternative being considered by the Fed is to induce inflation with the intent of jumpstarting the economy. It would also allow debt to be repaid with cheaper dollars but that will simply pass the problem on to those on fixed incomes, and future generations. At this point, we would crush the economy by raising taxes enough to start reducing the debt or create riots and major social unrest by cutting spending to the point to make any difference.

The hope that the economy can grow its way out of the problem in the current global economic environment is highly improbably in the short term, because almost every major economy in the world has been pursuing the path of more debt. We never seem to learn from the experience of others. As Douglas Adams was once quoted, "Human beings (and I could add governments), who are almost unique in their ability to learn from the experiences of others, are also remarkable for their disinclination to do so."

If President-elect Trump is successful in getting legislation passed to rebuild the U.S. infrastructure, military and border security, the deficit will continue to build, even if economic growth does increase.

My biggest concerns are that the next recession could not only be severe, but longer lasting than any since the Great Depression, and that interest rates could rise to cover the increased risk premium. The current weighted average interest rate on the federal debt is just over 2% and interest costs make up just under 7% of federal spending, so even at the current debt level, every 1% increase in the interest rate would result in a significant increase in government spending.

The effect would spill over to the farm sector in two ways; one, the cost of borrowing new money and existing variable or adjustable rate debt would increase, and two, the increased capitalization rate would cause land values to fall.

This isn't intended to be a gloom and doom article. I intend it to serve as a cautionary warning and to point out that government spending in excess of the rate of economic growth -- even if for income redistribution purposes -- needs to consider the payback in terms of productivity and improvement in social equity. Just giving money without a requirement and realistic expectation for economic benefits in return is why every socialist experiment in history has failed.


Editor's note: Danny Klinefelter is an agricultural finance professor and economist with Texas AgriLIFE Extension and Texas A&M University. He also is the founder of the mid-career Texas A&M management course for executive farmers called TEPAP. To read all of Klinefelter's recent DTN columns go to….