“Exigencies are to be expected to occur, in the affairs of nations, in which there will be a necessity for borrowing. Borrowing in times of public danger, especially during foreign wars, has been found to be essential, even for the wealthiest nations . . . A nation’s creditworthiness is crucially important and must be well established . . . I believe that properly managing the current debt will bring national benefits. However, I strongly disagree with the idea, sometimes put forward, that public debts are always beneficial. This position can encourage reckless spending and dangerous misuse of debt — instead, debt creation should always be accompanied by a plan for repayment. (Emphases added)” — Alexander Hamilton, “The First Report on Public Credit“
The debt ceiling of $31.4 trillion was reached by the United States on January 19, 2023, a limit that was approved by Congress just two years ago. To prevent the nation from defaulting, the US Treasury is now implementing extraordinary emergency measures.
The ongoing battle over the debt ceiling highlights an uncomfortable reality that the nation must face. Alexander Hamilton refers to two important principles in the above quote. The first principle is that maintaining the creditworthiness of the United States is crucial for its economic well-being. Voluntarily defaulting on federal debt would undermine the foundation of the country’s economic success. The second principle is that the current path of unsustainable fiscal deficits could eventually lead to an involuntary default in the future, with equally catastrophic consequences.
These uncomfortable truths have significant implications:
Key Points
- In 1790, the United States faced financial difficulties following the Revolutionary War and ratification of the Constitution. Alexander Hamilton, the first secretary of the Treasury, understood the importance of creditworthiness in ensuring economic prosperity. To restore the nation’s credit, he implemented various measures including consolidating war debt, instituting tariffs, and creating a central bank.
- After World War II, the United States shifted its approach to public credit, with peacetime deficits becoming the norm. The current trend of deficits averaging 5% of GDP per year is unsustainable in the long term, especially considering the aging population and declining productivity.
- The US dollar’s status as the world’s reserve currency and the expansion of entitlement programs contributed to the nation’s ability to amass debt. However, the costs of these programs exceed the country’s ability to fund them, particularly as Social Security, Medicare, and Medicaid expenses grow with the aging population.
- Refusing to raise the debt limit and defaulting on the debt would cause significant harm to the US economy. While the consequences of a future default cannot be predicted, they would likely be severe.
- The United States should address its unsustainable debt accumulation to avoid burdening future generations with unaffordable debts or the need for drastic reductions in living standards.
- The nation has historically united during times of crisis, and this unity has helped overcome challenges. However, the decline and collapse of past great powers serve as a reminder that there are no guarantees for the future. Resolving the debt problem will require painful solutions and sacrifices.
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All posts are the opinion of the author and should not be considered as investment advice. The views expressed do not necessarily reflect those of CFA Institute or the author’s employer.
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