Personal Finance: Debt and deficits from 30,000 feet

Christopher Hopkins
Christopher Hopkins

It is practically received wisdom that the United States is laboring under a debt crisis. Or is that a deficit crisis? And to whom do we owe all this debt? In discussing the financial state of the Union, it's easy to get lost in the jargon and the rhetoric. Here's a brief primer to help better understand the news reporting and better inform the debate about America's finances.

photo Christopher Hopkins

A deficit is a shortfall, borrowed directly from Latin for "it lacks." Each year, government accountants tote up the revenue collected from taxes, fees, duties and asset sales. For the fiscal year ending Sept. 30, 2015, total federal revenue was $3.25 trillion. A huge number by any standard.

Meanwhile, the U.S. government spent a whopping $3.69 trillion on everything from Social Security and Medicare to highway construction and interest on government bonds. Clearly, this number is bigger. The shortfall of revenue over spending was roughly $440 billion for 2015. This shortfall is the budget deficit, which must be made up through borrowing (issuing U.S. Treasury bonds). Each year, a new tally is made, so a budget deficit is the shortfall of revenue for a single given year.

We have experienced budget deficits every year since 1970, with the notable exception of 1998 to 2001. During those four years, revenue exceeded spending and the U.S. government ran a surplus as the result of spending restraint and exceptional economic growth.

As time progresses and successive annual deficits pile up, more and more borrowing is necessary to balance the books. The sum total of all outstanding borrowing by the U.S. Treasury is referred to as the national debt, and that sum is truly humongous: $19 trillion, equivalent to about $160,000 per family. This massive number represents sum total of all the annual deficits, netted against the rare surpluses, and is slightly greater than the entire value of economic output of the U.S. for 2015.

There is little debate over the threat to our prosperity and global standing that such an enormous debt load poses. And as the past few election campaigns have demonstrated, there is little agreement on the best formula for reducing the debt. Still, the debate is permeated with hyperbole and misunderstanding regarding the composition of the debt and the identity of our creditors.

Is it true that China owns all our debt and could pull the rug out at any time? Well, not exactly.

A substantial portion of our national debt is owed to ourselves. Various agencies within the U.S. Government like the Social Security Administration hold Treasury bonds in their reserve or trust funds. These intra-governmental holdings make up about 30 percent of U.S. debt. Another 13 percent sits on the balance sheet of the Federal Reserve as the result of monetary policy actions taken in response to the recession.

American businesses like banks and insurance companies as well as mutual funds and individual investors choose to safeguard their large cash holdings in Treasuries to the tune of $2.3 trillion or about 12 percent of our outstanding debt.

All foreign countries that trade with America accumulate surplus dollars in the course of business, and Treasury bonds provide a safe place to stash those dollars. Foreign government holdings account for about one third of U.S. debt, of which China owns $1.2 trillion or just 6.4 percent. Not exactly the Sword of Damocles.

This is certainly not to downplay the impending threat of mounting debt; the Congressional Budget Office warns that we are on a pace to reach $24 trillion by 2026. But an informed debate begins with understanding the terms and clearing away the misconceptions.

Christopher A. Hopkins, CFA, is vice president and portfolio manager for Barnett & Co.

Upcoming Events