America’s debt pile is big—but that doesn’t mean the economy is doomed. [Wednesday: The Independent Investor]

Today, we’re going to talk Curious?

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America's debt debate is back in the headlines.

A recent Bloomberg Opinion piece warned that the U.S. is pulling the country toward a “fiscal black hole.” The report behind that warning, a new Brookings Institution chartbook, gives the bears plenty to work with.

This year, debt held by the public is about 101% of GDP. The all-time high was 106% in 1946. Under Brookings' current policy baseline, public debt will reach 137% of GDP by 2036.

To put that in dollar terms: Today's public debt is roughly USD 31 trillion. Brookings expects it to climb toward USD 56 trillion by 2036.

Those numbers have many worried that the U.S. is going towards a point of no return, and that the only potential solutions are a default or an inflation surge.

Right now, the federal government has backed itself into a corner. The deficit doesn't seem to be shrinking anytime soon while the federal budget is giving policymakers less room to maneuver.

That’s why in today’s article, we will be talking about the U.S.’ debt picture, and reveal why you shouldn’t panic about the nation’s debt pile right now.

The Real Pressure Point

Professor Joel Litman , Chairman and CEO of Valens Research and Chief Investment Officer of Altimetry Financial Research , said that the real pressure point in America’s debt picture is debt service.

The federal government brought in roughly USD 5.2 trillion in tax revenue last year. Brookings projects that number will reach USD 5.5 trillion this year.

That figure makes the U.S. the largest tax base in the world. Unfortunately, that's still not enough to cover Washington's current spending path.

The U.S. is expected to spend USD 7.5 trillion this year, translating to a deficit of roughly USD 2 trillion, right in the middle of where it has been for the past few years. The deficit was as low as USD 779 billion in 2018 and as high as USD 3.1 trillion in 2020.

The Brookings report warns that if current federal policy remains the same for the next decade, the annual deficit will surpass USD 4 trillion by 2036.

That sounds scary, but just because the deficit crosses a certain number doesn't mean the borrower is automatically in trouble.

The trouble starts when the borrower can no longer service the debt. That's why it's so important to keep an eye on interest expenses.

Brookings estimates net interest costs were USD 970 billion last year. That's less than one-fifth of tax revenue. So the U.S. has plenty of cash to cover the interest on its debt.

The good news is, even if the government has to borrow more, Professor Litman says it can do so for cheap.

Washington is still borrowing at an average rate of 3.4%. The inflation-adjusted rate is about 0.5%. Based on that average rate, every USD 1 trillion of new debt adds about USD 34 billion of annual interest expense.

In a roughly USD 30 trillion economy, that's not an immediate breaking point.

That brings us to the important aspect of the debt equation people forget about.

The Debt-to-GDP Ratio

The debt-to-GDP ratio has two pieces. Everyone tracks the debt as it climbs. However, GDP matters just as much.

A growing economy generates more tax revenue and reduces the ratio, even without paying down a single dollar of principal. Said simply, you don't have to shrink the debt if you can grow GDP fast enough.

Straight-line projections make the debt story look like a doomsday counter. However, economies don't move in a straight line.

The truth is, we don't know what will happen to the U.S. over the next decade. If the deficit does reach USD 4 trillion, that's not an issue if the economy grows to match it.

Brookings' chartbook shows tax revenue staying near historical levels as a share of GDP in this same scenario.

In other words, it expects that new borrowed money will help grow the economy enough to pay off the higher interest load.

As long as that's the case, a higher debt number won't cause major problems.

That said, investors have to learn when to set aside fiscal discomfort. The U.S. has used debt through wars, recessions, infrastructure build-outs, research programs, energy systems, crisis responses, and more.

Borrowing to grow leaves the economy with greater productive capacity.

As long as the U.S. keeps servicing its debt and the economy keeps expanding, markets can still function as they should.

As Professor Litman has said, the debt clock is flashing. However, at the moment, it's still not a sell signal.

Hope you’ve found this week’s insights interesting and helpful.

Stay tuned for next Wednesday’s The Independent Investor!

There is a moment every seasoned investor dreads—not the moment markets fall, or volatility spikes, or headlines turn grim—but the quieter, more dangerous moment when the signals stop making sense.

Learn more about why you can’t trust the numbers anymore in next week’s article!