With the pending battle over the debt ceiling, we are once again hearing concerns about the magnitude of our national budget deficit and the seemingly overwhelming size of our national debt. Given those concerns, it is important to have a clear understanding of how deficits and debt impact the U.S. economy. For that, we need to look at the overall financial status of not just the U.S. government, but of U.S. households too.
In 2020, during the darkest hours of the global coronavirus pandemic, the U.S. government spent $3 trillion to help rescue the country’s—and, to some extent, the world’s—economy. This infusion of cash increased government debt and thus reduced government wealth by almost the entirety of that frighteningly large amount—the largest drop in nominal U.S. government wealth since the nation’s founding. Surely something this unfavorable to the government’s financial condition would have broad, adverse financial consequences.
So what happened to household wealth during that same year? It rose. And it grew by not just the $3 trillion injected into the economy by the government, but by a whopping $14.5 trillion—the largest recorded increase in household wealth in history.
Given the pending debate on the debt ceiling, and the perennial debates on spending that dominate the halls of Congress, it is crucial to understand the relationship between government debt and household wealth. Conventional wisdom states that the government is incurring debt that will burden our children and grandchildren, yet the data shows that households already have the funds generated by this debt as part of their current wealth. In 2022, the prestigious Peter G. Peterson Foundation argued: “Federal borrowing…crowd[s] out new investment,” yet household wealth has increased dramatically in the very period that this debt has grown most rapidly. The policy decisions we make on spending should be informed by the data on debt and wealth.
Drilling Down on the Numbers
How and why did household wealth increase by such an extraordinary amount in 2020?
To answer that question, we need to look at the key subcomponents of the U.S. economy: households; non-financial businesses; financial institutions; the federal government; state and local governments; and the rest of the world (ROW), which is defined as the net of all transactions—especially trade transactions—with foreign households and other foreign entities. We refer to these as the six “macrosectors” of the economy.
Figure 1 shows U.S. income statements—which are straightforward records of income (or revenue) and expenses—broken down by these macrosectors for the years 2019 and 2020. These statements record the economic transitions that came as a result of the pandemic and the battle to contain the spread of the novel coronavirus. Revenue minus expenditure and investment yields “net income,” just as an individual household’s net income is the difference between its total income and total expenses. (Note that the “disposable income” entry corresponds to “total income” minus taxes and depreciation. The memo entry “gross value added” is each sector’s contribution to GDP as measured using the output approach.)
FIGURE 1: U.S. income statements, 2019 and 2020
By definition, for every expense within any of these macrosectors, there has to be corresponding income, either within that macrosector or in another one. Typically, a government expense results in income to the household sector, such as a paycheck to a soldier or government official—or in 2020, the $1,200 pandemic relief checks. These are expenses to the government and income to households that equal each other, such that the effect on the resulting national net income statement is zero. Expense always equals income in an economy.
This illustrates a basic feature of dual-entry accounting. As its name implies, dual-entry accounting simply involves making two entries. In the world of accounting, when you record income—say, the bonus check you received from your company—you also record that money as an expense to your company. You can never make an entry for a liability (your mortgage, for example) without simultaneously making an entry for the corresponding asset (the house you purchased). Everything balances. Dual-entry accounting reflects the reality of economic systems and governs how records are kept for businesses, individuals, and payment systems worldwide.
When studying an entire economy, a key point of clarification is that expenses and income still net to zero—but only when we include transactions with the rest of the world (ROW). If the net income of the ROW is positive in a country’s income statement, that means the ROW is making money at that country’s expense. It shows that that country has a current account deficit, the biggest part of which is normally a trade deficit. If, on the other hand, the net income of the ROW is negative in a country’s income statement, that country is making money at the expense of other nations. By the rules of dual-entry accounting, the total net income of any given country, when including the net income of the ROW, always totals zero. (That’s true even with the frequent talk of the government “printing money,” since, instead, what the government actually does is issue debt.)
With these fundamental ideas in place, let’s now examine U.S. income statements and balance sheets for 2019 and 2020. This will involve several charts and a few paragraphs of detailed description, but drilling down in this way will help to convey crucial concepts for understanding the state of the modern global economy as well as provide useful context for the current debt ceiling fight.
The Truth About Our Pandemic Spending Spree
In most countries, the household macrosector has the largest net income. For U.S. households in 2019 that amount was $870 billion (letter C in Figure 1). The second largest net income was the $490 billion made by the ROW, which is to the detriment of the domestic macrosectors, because it means less net income (and more debt) for them.
The key year of 2020 brought the largest increase in government spending in U.S. history, and therefore the largest-ever government deficit, as shown in the bottom part of Figure 1. The federal government deficit shows up as a negative value for the government’s net income (both letters D in Figure 1). A major surge in government spending—primarily spending on pandemic relief programs—increased the deficit from $1.16 trillion in 2019 to $3.07 trillion in 2020.
As a result, following the principle that overall income must equal expense, the government’s larger net loss must have been balanced by one or more other macrosectors that saw a corresponding income gain. Remember: One entity’s expense is another entity’s income. And in fact, household net income (both letters C) went from $870 billion in 2019 to a whopping $2.52 trillion in 2020. The unprecedented increase in government spending came hand in hand with an immense rise in income for households. Indeed, most of the government’s expenditures were payments to the U.S. private sector, including direct payments to households, such as the $1,200 and $1,400 pandemic relief checks that were sent to U.S. citizens and taxpayers. But even in cases where the government paid a vendor from the U.S. non-financial business sector, a portion of that government spending ended up in that vendor’s employee salaries, and thus eventually made its way to the household sector. Government spending results in higher household net income. Note that while I call the amount of household income in excess of expenses “net income,” most economists refer to it as “net saving.”
Naturally, not all of the increase in net income due to government spending went to households. Both non-financial businesses and state and local governments improved their overall net income position from 2019 to 2020, albeit by (relatively) small amounts, as seen in Figure 1.
I want to be clear as to what I mean by household net income in this context. A positive net income certainly means that households’ total income exceeds their expenses by the amount of that net income. In this case, it also means that total household revenue has been augmented by payments directly from the government. So household revenue is higher than it otherwise would have been. Net income shows the increase. The key is that a positive household net income indicates that households are getting a transfer of wealth from somewhere—in this case (as in many cases), from the government in the amount of the government’s spending and deficits.
This increase in net income is the record of the U.S. government achieving its pandemic relief goals of helping families in need—and in so doing it restored overall economic growth. It took some time, however: GDP decreased by $320 billion to $21.06 trillion in 2020 from $21.38 trillion in 2019, as Americans sequestered themselves at home for much of 2020 and spending plunged, though that plunge was partially offset by government relief programs. But the government relief programs spanned two years, and with that multi-year boost from the government’s spending, GDP rose to $23.32 trillion in 2021 and $25.46 trillion in 2022, essentially where it would have been had the pandemic never happened (but no higher).
When U.S. Debt Rises, Households Get Richer
Let’s turn now to the same critical metric—net income—for the six macrosectors in the United States, but look at a much longer time frame, from 1946 to 2021, to determine whether what occurred in the years we have just looked at holds true through time or was an aberration. Figure 2 shows net income (or loss) by macrosector as a percentage of GDP each year so that we can see the relative change through time. These income statements use the cash accounting method, whereby all expenses, even large ticket items that are purchased with debt, are recorded as expenses to the buyer and income to the seller at the time they are purchased.
In Figure 2, a pattern becomes clear: The two largest macrosectors are typically households and the government, and in most years, households post the highest net income of the six macrosectors and the government posts the largest loss. The positive net income of households roughly mirrors the negative net income of the federal government. This is not surprising from an accounting perspective. Because all sectors’ income nets to zero, you would expect that the two most significant macrosectors would be strongly inversely correlated.
FIGURE 2: U.S. net income by macrosector, 1946–2021
However, during this extended period, there were two periods of time in which this pattern was partly broken, where the household macrosector did not make far more (positive) net income than any other sector. These exceptions occurred during the frenzy immediately preceding the two main U.S. banking crises of the postwar period: the savings and loan and commercial real estate crisis of the late 1980s and the global financial crisis of 2008. In the years immediately before those two financial crises, rampant growth in lending—including, at times, the irresponsible lending that directly provoked each crisis—fueled a household spending spree. Household net income declined sharply as households spent more on expensive imports and home purchases. A good portion of the benefit of that spending went to the ROW, which posted record high net income. The net income of the other two macrosectors—non-financial businesses and financial institutions—is smaller in comparison. (When we look at the other largest countries, we see similar patterns, with one of the net income numbers in the graph consistently being the most negative in an economy. In most of the countries the dominant loss is incurred by the government, as it is in the United States.)
The two most important financial statements in financial analysis are the income statement and the statement of condition—or “balance sheet”—which we will look at now. While income statements list items like salary income and food expenses, balance sheets include assets and liabilities such as the value of the home you own and the outstanding balance you owe on your mortgage. Figure 3 shows the 2019 and 2020 balance sheets for the United States, broken down by macrosector. They confirm that households are receiving wealth transfers as a result of government spending.
Figure 3: U.S. balance sheets by macrosector, 2019 and 2020
The 2020 U.S. income statement (Figure 1 above) noted that the federal government had a net loss (deficit) of $3.07 trillion, while households had a net income of $2.52 trillion. The dramatic rise in the government deficit is reflected in its balance sheets, with the government’s net worth declining from 2019 to 2020. With its loss in that year, the federal government’s net worth declined by $3.1 trillion (both letters A in Figure 3), though the government also had an increase in its own assets, primarily funds it had raised but not yet spent, which partially offset its significant spending on pandemic relief programs (both letters B in Figure 3).
Losing $3.1 trillion in a single year sounds pretty terrible, right?
Yet this government spending did not cause widespread suffering among households. Quite the contrary. Household net worth increased from 2019 to 2020 by $14.5 trillion, in part because government spending added trillions to household bank accounts (both letters C in Figure 3). In addition, the value of household-owned stocks (and ownership of non-corporate businesses, such as partnerships) increased by $7.6 trillion (both letters D in Figure 3), while the value of household-owned real estate increased by $3.3 trillion (both letters E). Together, these two categories of assets account for a striking $10.9 trillion out of the $14.5 trillion by which households’ assets increased from 2019 to 2020 (both letters F).
Why did stocks and real estate go up during this period, at a time when government debt was rising? While real estate and stock values change dynamically (and can sometimes be volatile, especially in the case of equities), over the long term an increase in debt tends to lift the value of both of these asset types. The flood of U.S. government and Federal Reserve support during the pandemic primed the pump for a surge in stock and real estate prices. The ostensibly frightening increase in government debt was accompanied by an even larger increase in household net worth. So, even though total federal government debt reached the record level of $26.6 trillion in 2020, there would simply have been that much less in private sector wealth, primarily household wealth, if the government debt had not existed.
This is a critical concept: When a government spends, the money does not disappear. Instead, most of it ends up in the coffers of households. We see similar mirroring of household net worth and government debt over a longer period when we look at the balance sheets of the six U.S. macrosectors through time. Figure 4 demonstrates that household net worth trends higher when government net worth trends lower. (Contrary to net income, net worth is not zero-sum; it can increase in the economy as a whole.)
FIGURE 4: U.S. total net worth by macrosector, 1950–2022
From 1950 to 2021, U.S. household total net worth grew from 376 percent of GDP to 654 percent of GDP, while federal government total net worth declined from negative 43 percent to negative 88 percent, briefly rising to negative 11 percent along the way. This trend was particularly pronounced after something I call the Great Debt Explosion, a marked rise in total debt to GDP that started in the 1980s.
Looking at just the three years of the pandemic—2020, 2021, and 2022—the net worth of the federal government declined by $6.2 trillion (only $1.8 trillion if you add in gains by states and local governments), and at the same time, the net worth of households increased by $30.8 trillion. This includes the impact of the 2022 stock market correction, since those markets are still well above their 2019 level even with the recent reversal.
The long-term pattern is this: Household net worth increases at a rate faster than the government’s net worth declines—although that path is often bumpy. And as for the oft-repeated concern that the federal debt, now at $31.4 trillion, is at a level that our children and grandchildren will never be able to repay, the reality is that households already have that $31.4 trillion. They received it as it was being spent. It’s a part of the $148 trillion in net worth that U.S. households had as of December 2022.
Now, this increase in household net worth has played out in a very unequal manner, with those among the top 10 percent by income receiving the lion’s share of the benefit, and thus rising inequality is itself a product of this rise in debt. But that is another (very important) topic for another article.
And What About Inflation?
Some might say that this analysis ignores the consequence of inflation, and that government debt and money supply growth have now wracked the U.S. economy with runaway prices: Inflation peaked at 9.1 percent in June 2022, though it is down to 4.98 percent as of March. Notably, the analysis in this article looks at net worth as a percent of GDP, so it already fully takes into account that inflation as regards the impact on net worth.
But inflation has gravely impacted Americans’ daily lives, so it is important to understand whether it was caused by money supply growth, government debt growth, or something else entirely. The strong belief that it is a function of loose monetary policy has led directly to the Federal Reserve engineering one of the sharpest increases in interest rates in post-World War II history, an increase of 500 basis points, bringing significant damage to the economy. How convincing is the case that loose monetary policy was in fact the culprit causing inflation?
While the extraordinary growth in the U.S. money supply during the pandemic is in some respects unique, when my colleagues and I scoured a database covering macro statistics for 47 countries since World War II, we found only 30 instances where the money supply doubled in five or fewer years. Of these, only seven were followed by inflation—meaning that more than three-quarters of the time, high money supply growth was not followed by high inflation, and further, high inflation was often not preceded by high money supply growth. A similar pattern holds for high government debt growth.
This means that, over time, inflation has not been particularly well correlated with increases in government debt or the money supply. In keeping with that, Japan’s ratio of money supply to GDP increased almost 35 percent in the years after the global financial crisis of 2008, and yet the Japanese economy saw zero inflation for the next several years. In the same span of time, the U.S. money supply almost doubled and the U.S. economy averaged just 2 percent inflation.
Our exaggerated fear of inflation comes from the 1970s and ‘80s, when OPEC led a tenfold increase in the price of oil, inflation reached a 15 percent annual rate, and interest rates climbed close to 20 percent. It was in this context that many economists made dire predictions about the likely consequences of high levels of money supply and government debt growth. They warned that high government debt would constrain spending, crowd out lending and investment, lead to higher interest rates and inflation, and seriously encumber the country. Since then, government debt growth and money supply growth have exploded, and so we have had ample opportunity to put these predictions to the test. As it turns out, over this very 40-year period, interest rates have generally plummeted, not risen (even with the recent rise); investment has remained high, not been constrained; and household net worth has risen, not sunk.
Our current inflation has been largely caused by global supply chain issues related to COVID and by supply disruptions in such commodities as oil, natural gas, and wheat brought on by the war in Ukraine. Our current inflation trends have more to do with the war than the Fed. If history is any guide, inflation will decline as these special circumstances abate.
Through March 2023, we’ve now had nine consecutive months of fairly benign monthly inflation—and in those same nine months, producer price inflation has been negative, so inflation is now much less of a concern. It never came close to the 15 percent peak in inflation of March 1980. Since government debt and the money supply did not cause this inflation, in our view raising interest rates by 500 basis points was not a requirement to address it, but the hikes will nevertheless bludgeon the economy enough to help bring inflation down. In fact, since the total debt-to-GDP ratio is now twice what it was in Paul Volcker’s 1980, interest rate increases have twice as much braking (and breaking) power today as they did then.
So, as we brace for what is sure to be an unprecedented level of Sturm und Drang in the coming debt ceiling battle, it’s important to understand the financial facts underpinning the drama. Even though there are reasons for concern regarding rising debt, especially its implications for inequality, the government debt we are incurring is not piling up for future generations. Nor is it “crowding out new investment.” Instead, the payments funded by that debt have brought concurrent increases in household wealth. The policy decisions we make on spending should be informed by this understanding.
This article has been adapted from Richard Vague’s upcoming book, The Paradox of Debt.