Helping Clients Understand the U.S. Debt Problem
America’s relationship with government debt is what the psychologists call co-dependency. We can’t live with it; we can’t live without it. We know it cannot last forever, but we love the benefits of government debt so much that we can’t leave it behind.
After six decades helping families and business owners manage their liabilities and money, I can tell you the first rule of debt: It is future consumption delivered in today’s dollars. Every borrowed dollar lets us live better today by agreeing to live on less money tomorrow unless we earn more. That rule applies to any borrower, including the U.S. government.
For a nation to earn more, it must either increase taxes or increase productivity. That’s tough to do because debt reduces productivity, as we’ll see in a minute. Unlike people and businesses, governments have unlimited capacity to create debt and it’s very hard to resist. But when you go down the debt road, the bill eventually comes due, and it won’t be easy for the government or any of us to swallow.
Too much debt negatively impacts growth. Weak growth requires Congress to act because its members always have an eye on the ballot box. So, their response is to solve the low-growth problem by spending more, which means more debt. And new debt further weakens economic growth. It’s a vicious cycle that will continue until Congress is forced to stop spending without accountability.
To put this into perspective, each additional dollar of debt generated about $0.60 of GDP in 1980. By 1989, each dollar of debt generated only $0.42 of GDP. By 2019, each dollar of debt generated only $0.27 of GDP.
The trend is clear: we’re borrowing more and producing less. No rational business owner or corporation would keep borrowing money if their return on borrowed capital fell by more than half. But Congress isn’t running a bottom-line business. It’s running a re-election machine. Besides, Congress isn’t spending its own money; it’s spending your and your kids’ money.
Don’t get me wrong. Debt can be a useful tool when used properly. It can level the income cycle and accelerate growth. Borrowing to build productive infrastructure makes sense. Toll roads are funded by revenue bonds and paid for by assessing fees to users based on congestion pricing, making it productive debt. So is rebuilding water systems by using public revenue bonds and paying for the project by increasing fees to retire the bonds . But when used improperly as it so often is, debt makes you a slave to interest.
Washington knows this formula, but it doesn’t have the political will to change it. The government borrows to fund current consumption. Medicare, Social Security, and interest on the debt itself are all beneficiaries of the deficit spending. Nobody would vote to strand a widow financially or deny a retiree the benefits they paid for 40 years ago. Necessity is always the rationale used when we borrow for consumption. But when there is no source of repayment, the end of the road is always the same: default.
The U.S. is the richest country in the world because it can borrow unlimited amounts of money to fund consumption. It’s unlimited as long as people are willing to buy it. The U.S. has built its dreams on borrowed money and the estimated $1.9 trillion deficit in 2026 is nearly 60% above the 50-year average deficit of 3.8% of GDP. And there is no willingness to stop doing it and then implement a plan for repayment.
Make no mistake about it, the piper is about to get paid.
Social Security will likely be one of the casualties. As I explained in my last column, the trustees project that Social Security will be broke by 2033. This means benefits will be cut by roughly 22% unless there is reform. The second severe consequence of the debt-fueled spending is the rising interest on the national debt. A $40 trillion federal debt means the interest is now $1.0 trillion. But that interest is based on a 3% rate, and rates are rising. Soon, interest alone will run between $1.2 and $1.3 trillion annually, ballooning to $2.1 trillion (5.6% of GDP) by 2036. That rate, as percent of GDP, assumes there is no recession.
Helping clients prepare
There’s no reason for your clients to panic, but they need to be prepared for what’s coming in the early 2030s, especially younger clients and high earners. Congress is not likely cut benefits for the vast majority of Social Security recipients. It would be political suicide. But there will likely be a higher benefit age for younger recipients, and benefits will be taxed at a higher rate for incomes above a certain threshold (i.e., means testing). Also expect an increase in payroll taxes (no cap). That would reinstate sanity to Social Security but leave the larger deficit untouched. At some point, the bond market will do what Congress can’t do.
It will say enough!
For clients who are risk-averse and rely on income from fixed investments, they may be facing a reduction in income. As advisors, this needs to be addressed, and a discussion of viable options should be included in your meetings.
Some may ask why the government doesn’t start issuing Treasurys at 2% instead of 4% and save the difference. The answer is subtle. Yield is a price that is set by market forces. The coupon rate is merely a label. The borrower (the government) does not get to set the price.
Assume the Treasury starts trying to sell bonds with a 2% coupon, but the market demands 4%. What happens? A $1,000 bond paying $20 is a no-go. So, the government will have to discount the purchase price ($1,000) until the yield is 4% for the market to buy it. This reduces the purchase price to $838, but the government still owes the full $1,000 at maturity. The market will only buy if it collects 4%. This will have the added detriment of reducing the value of bonds held by investors. In other words, the bond portion of a portfolio will decrease 10% to 15% when this happens.
Finding alternative sources of income may be difficult in a risk-averse world. The only way to discuss this is to provide options and let clients choose. Most likely, they will defer to you, so you need a philosophy about how to handle such questions.
Taxes will eventually have to increase more than any of us wants. Spending will have to be cut across the board. That puts the problem squarely in Congress’s lap to make the changes in the tax code that will keep the country productive. Will Congress act before the crisis hits or wait until we are in the middle of it? History shows it will wait until we are deep in the crisis before acting. That way, they can blame others and hope voters don’t punish them.
Advisors who recognize this problem will make adjustments for clients. Steps might include prioritizing liquidity, eliminating high-interest liabilities, and shifting toward defensive, high-quality assets that preserve purchasing power, like TIPS.
The U.S. has long prospered under excessive debt. The survivors will flourish once the reset has been implemented. But it will be tough medicine to swallow. That’s where you come in.
