What’s not clear in assessing the debt-to-GDP ratio is at what point the debt becomes unsustainable or has a negative impact on economic growth. Such residual effects are possible because increased taxes, lower federal government spending or both, aimed at lowering the debt, could be detrimental to the economy. “Many developed countries, such as Japan, have faced high debt-to-GDP levels, and still found ways to growth their economy,” says Merz.
Haworth points out that much of the nation’s long-term debt problem centers on growing deficits for Social Security and Medicare. “We have an aging population and fewer workers in succeeding generations to pay the costs of these programs,” says Haworth. “These are manageable budget matters, but they are not yet on voters’ radar, so Congress hasn’t yet seriously considered solutions to them.”
Potential investment implications of the rising national debt
While growing government debt draws increasing attention, an important question for investors is what the potential impact is on the long-term interest rate environment. What could it mean for fixed income and equity portfolios?
“If the supply of Treasury securities continues to grow to finance increasing government debt, there is a risk that it could put upward pressure on interest rates,” says Merz. “But that might not outweigh the impact of inflation, growth and Fed policy rates.” Merz believes the U.S. position relative to the global economy remains strong, which allows the federal government more time to address the debt situation before it results in significant economic ramifications.
Haworth says for equity investors, one key question is whether high interest rates potentially slow corporate borrowing activity. “Capital intensive projects require a payback that justifies higher borrowing costs,” says Haworth. “That has the potential to slow corporate borrowing activity and may prove detrimental to business activity and economic growth.” However, Haworth notes that many other factors could have a bigger impact on the long-term investment landscape.
For investors, the size of the national debt should not present immediate challenges. U.S. Bank continues to see opportunities in high quality bonds, including U.S. Treasury obligations. Investors benefit from the highest yields in years, which translates to steady, reliable portfolio income. Treasuries, along with other investment grade bonds, also possess important diversification properties that can improve portfolios’ long run returns relative to risk. We continue to monitor the government’s increasing debt burden and policies that influence long-run sustainability for signs of change in the broader investment landscape. Consider talking with your financial professional to make sure you have a comfort level with your current plan and investment position.