US Debt: Only Bits of Sky Will Fall

THE UNITED STATES economy is overloaded with debt relative to its income and net worth, reflecting imprudent policies of past years. Doom-and-gloomers look at this debt burden and say the sky is going to fall. But the sky won't fall. Pieces of the sky may fall, however, as policies are altered to lighten the relative debt burden. Total outstanding debt (the sum of federal government, household, nonfinancial, and other) of nearly $9.3 trillion at the end of 1988 amounted to $1.90 for each dollar of income. From 1950 to 1980, the ratio of debt to income was $1.46 per dollar of income. The 1980 ratio was $1.50.

The Reagan years were characterized by a huge debt boom as debt increased more than 25 percent faster than income and 50 percent faster than net worth. Each dollar of the economy's $14.6 trillion net worth, for instance, currently has 63 cents of debt stacked against it, compared with an average of 47 cents from 1950 to 1980. In 1980, the number was 42 cents.

The US economy is still solvent but significantly more leveraged.

Is this increased leverage prudent? There is no economic dimension that says a larger aggregate debt burden relative to income and net worth is prudent. So the answer must be no.

The federal government is the biggest culprit in the 1980s debt boom, as federal debt grew at about double the rate of income growth. In the 1950 to 1980 period, federal debt outstanding grew at about half the pace of income. Federal debt as a percentage of total debt declined from 51 percent in 1950 to 18 percent in 1980. In 1988, that proportion had risen to 23 percent.

Household and nonfinancial business debt grew from a combined 40 percent of total debt outstanding in 1950 to approximately 70 percent by 1980. That large relative increase was not a problem as long as relative federal debt was decreasing.

Today's debt boom is policy-driven.

A policy of interest-expense deductibility drove nonfinancial business and household debt faster than income for decades. In addition, the Reagan administration policy of relaxing merger guidelines in 1982 contributed to increases in mergers and leveraged buyouts, resulting in increased corporate debt use. Thus both nonfinancial business and household debt grew faster than income during the Reagan years.

The cumulative federal deficit added a $1.4 trillion debt burden during the 1980s. That burden reflects administration and congressional priorities on tax revenues and expenditures. The Federal Reserve-induced 1981-82 recession also significantly lowered tax revenues and, again, that was a policy decision.

Milton Friedman, in a Dec. 14, 1988, article in the Wall Street Journal makes the argument that ``the deficit has been the only effective restraint on congressional spending.'' So while the ``deficit'' is a hidden tax, ``it is currently preventing the imposition of a still larger and still worse tax'' - additional federal government spending increases. Federal government spending is slowing, leading to smaller deficits and smaller additions to debt.

An illustration of a policy change to slow debt use is altering the 1986 tax code to eliminate deductibility of consumer installment interest expense. That piece of ``sky''' may be falling, in part, on the auto industry. Previously the tax code gave a subsidy to folks who purchased autos with consumer installment loans. The phasing out of that subsidy should slow use of installment debt.

Merger guidelines will probably slowly be stiffened in the Bush administration so as to have the effect of slowing debt use in the corporate sector. James Rill, the Justice Department's antitrust chief in the Bush administration, is likely to interpret the Sherman and Clayton Acts to bring this about.

Finally, any progress the Federal Reserve makes on achieving price stability will help reduce a bias toward debt, since borrowed dollars can be paid back with cheaper dollars. Further, the monetary policy followed during the past year has created a slowdown in consumer spending, which will also slow debt use.