Debt Ceiling Green Road Sign Over Clouds and Sky.

There are many issues that concern us as investors but the one we hear the most from our clients is worry over the magnitude of our country’s indebtedness.  Consider that federal indebtedness has spiked from about $5 trillion 20 years ago to about $17 trillion now, and currently stands at a whopping  102% of Gross Domestic Product (GDP).  On the surface, it does sound alarming.  Many assume that this situation will lead us into certain economic doom.

While we at McDaniel & Register are not advocates of deficit spending, it is important to see how this problem might work itself out (and HAS worked itself out in the past).  We believe that overtime, as the Fed continues its long-standing policy targeting modest inflation, that we can work our way out of this in an orderly manner.

Here is how inflation helps to ease our country’s debt burden.  At the risk of over simplifying, it works like this.  As prices rise, GDP increases.  As GDP increases, tax revenues increase.  As tax revenues increase, servicing debt becomes easier.  Look back 20 years to the mid-1990s.  At that time, GDP was approximately $7.5 trillion; it has more than doubled to $17.4 trillion.  In the same period, tax revenue for the US increased from $1.5 trillion to $3.0 trillion.  Servicing debt becomes much easier when your income doubles.  Most of the increase in GDP over the last 20 years has come from inflation.  So that is how we see inflation helping us emerge from our current levels of indebtedness.

It may comfort you to know that this is not the first time federal indebtedness exceeded GDP.  Just after WWII, federal debt was 116% of GDP.  We worked out of it then and we believe we’ll work out of it again.

 

Sources

www.databank.worldbank.org
www.useconomy.about.com
www.taxpolicycenter.org
www.usgovernmentrevenue.com

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