The Tapestry of Debt and What We Need To Do To Unravel It

Thoughts on the current US debt challenge and the long-term implications for markets and the economy from Stephen Dover, Head of Franklin Templeton Institute.

While the current debt ceiling negotiations are creating near-term volatility across the capital markets, the issue of rising national indebtedness is a long-term story, with potentially long-run implications.

Rather than speculate on how the near-term politics will play out, we believe it is more important to explore the root causes of high levels of government debt and what that may mean for growth, inflation, and other fundamentals impacting asset prices in the long term. Specifically, what accounts for the explosion of national government indebtedness over the past 15 years? Is the root cause surging expenditures or falling tax revenues, or both? How does the federal government collect taxes and what accounts for its spending? Is there precedent for reducing government indebtedness and, if so, what are the likely implications for the economic fundamentals?

Why has US debt risen so fast?

Since 2007, US federal government debt—whether expressed in dollars or as a percentage of US gross domestic product (GDP)—has mushroomed. At the end of 2007, on the eve of the global financial crisis (GFC), the size of US federal government debt was US$9.2 trillion, or 62.7% of GDP. A decade and a half later, at year-end 2022, total federal government debt had reached US$31.4 trillion, or 120.2% of GDP.1

While the United States has run persistent budget deficits over the past decade and a half, two major events—the GFC of 2008-2009 and the pandemic of 2020-2021—massively increased the size of US budget deficits.

Exhibit 1: US federal government spending and revenues as a percentage of GDP 1968-2033

US Fiscal Budget as a Percent of GDP