Slow M2 means low CPI

Long-time readers of this blog know that I have been one of only a handful of observers who have linked rapid M2 growth (i.e., money printing) to the big inflation problem that hit the US economy beginning in the first part of 2021. The source of the M2 growth was the government's decision to send out some $6 trillion of checks to the public to compensate for Covid shutdowns and their damaging effects on the economy. At first, most of this money sat idle in consumers' checking and savings accounts as a hedge against great uncertainty and also because consumers had little ability and little willingness to spend it. This amounted to an enormous increase in the demand for money which effectively neutralized the enormous increase in the supply of money. But as life began to return to normal in early 2021, the demand for money declined, and the money was released (monetized) into the economy. Unwanted money fueled a dramatic increase in the price level (otherwise known as inflation). 

Fortunately, this problem began fading away more than two years ago, and it continues to do so. Money supply and money demand have returned to more normal levels, and inflation (abstracting from the government's flawed measure of shelter costs) has been 2% or less the for the past year or so. 

Regardless, it is still vitally important to monitor money supply and demand. So far, nothing out of the ordinary seems to be happening, and that implies no unpleasant inflation surprises for the foreseeable future. The following charts include M2 as of the end of September, and my estimate for Q3/24 GDP. 

Chart #1

Chart #1 shows how the surge in the federal deficit was mirrored by an increase in M2 growth. The link between the two dissolved in the latter half of 2022, with the result that ongoing deficits, though still quite large, are no longer being monetized.

Chart #2

Chart #2 tracks the level of the M2 money supply (currency, retail savings and checking accounts, CDs, and retail money market funds). From 1995 through late 2019 M2 grew at a fairly steady rate of 6% per year, and inflation was relatively low and stable. M2 then surged beginning in April '20 and peaked in early '22. M2 now is only about $1.6 trillion above its 6% trend growth line, and is growing at a modest 3-4% annual rate. 

Chart #3

As Milton Friedman taught us, inflation happens when the supply of money exceeds the demand for it. The Fed publishes the M2 measure of money supply once a month. But nowhere will you find a measure of money demand, except here. My measure of money demand is driven by dividing M2 by nominal GDP, which is shown in Chart #3. The best way to understand this is to think of it as the amount of cash and cash equivalents the average person wants to hold relative to his or her annual income. As the chart shows, money demand tends to rise during recessions, and to decline during periods of growth and stability—with the exception of the 2009-2019 period, when it steadily rose. 

Money demand soared in the wake of Covid shutdowns, then began to fall as Covid fears faded and the economy revived. It is now only modestly higher than in the pre-Covid period. Money supply and money demand, I would argue, are now back in balance, and that explains why inflation has declined and is likely to remain low.

Chart #4

Chart #4 shows M2 growth (blue line) and the year over year change in the CPI (red line, shifted one year to the left). From this perspective, inflation picked up about one year after M2 surged, and it began to decline a year or so after M2 growth peaked. The red asterisk marks the change in CPI ex-shelter costs, which is, I think, the appropriate measure to watch. The chart further suggests that inflation has fallen pretty much as you would expect, given the decline in M2 growth, and it is likely to remain muted for the foreseeable future. 

The enormous net worth of the US private sector

This post extends a series of similar posts I've made over the past 15 years. It highlights the net worth of the U.S. private sector: the net value of assets and liabilities of individuals and non-profit organizations.  As of June '24, the total net worth of the U.S. private sector was $164 trillion, and the net worth of the average person living in the U.S. was almost half a million dollars. 

Does the proliferation of billionaires distort the picture? Not much. According to Forbes, at last count the U.S. had 2,800 billionaires, whose net worth totaled in the range of $17-20 trillion. The net worth of the Forbes Top 400 billionaires totaled $5.4 trillion. If we exclude all billionaires from the total, the net worth of the average American would be about $425K, which is still pretty impressive.

Chart #1

As Chart #1 shows, private sector net worth has increased by 167% over the past 20 years, and now stands at $164 trillion. The biggest gains have come from financial assets (stocks, bonds, and savings accounts), which have increased 149%. Real estate assets have increased 144%, while liabilities have increased a mere 44%. The federal government is heavily indebted, but not so the private sector! 

Chart #2

Chart #2 shows the real, inflation-adjusted value of private sector net worth. Net worth peaked at 166.7 trillion in December '21, and has since declined to $164 trillion. The rather spectacular gains of the stock market and housing in recent years have been diluted by inflation. Still, real net worth is still on a rising path, averaging gains of about 3.6% per year.

Chart #3

Chart #3 divides real net worth in Chart #2 by the U.S. population (about 342 million). Real per capital net worth peaked at $509,500 in 12/21, and fell to $481,000 through June of this year, due to the effects of inflation and an increasing population. Still, it has risen on average by about 2.4% per year. If this continues, by 2054 the average American will be worth $1 million in today's dollars. 

Federal spending is the problem, not taxes

Given the upcoming elections and all the "disinformation" floating around,  it's worthwhile clarifying some of the facts behind fiscal policy. 

As the following charts show, our biggest problem is too much spending, much more so than any shortfall of tax revenues. 

Chart #1

Every taxpayer should frame Chart #1 and put it somewhere prominent. This shows the staggering increase in both federal spending and federal tax revenues in recent decades. 

Chart #2

Chart #2 shows the major components of federal revenues, all of which—with the exception of the estate and gift tax—have surged in recent decades. Individual income tax receipts have almost quintupled since 1990! And by the way, eliminating the "death tax" would amount to a rounding error in the federal budget, since it collects only 0.6% of total federal revenues. Think of how much more efficient our economy would be if millionaires and billionaires stopped spending big bucks on tax attorneys in order to escape this onerous tax. The negative impact of this tax on the economy is an order of magnitude larger than the revenues it manages to generate. 

Chart #3

Chart #3 shows federal spending and revenues as a percent of GDP. Note that spending has averaged a bit less than 20% of GDP since WWII, while today it is about 23% of GDP. Bringing it down is going to be difficult, since interest payments on federal debt now add up to more than $1 trillion per year (3.8% of GDP currently) and are rising (see Chart #4). Meanwhile, revenues have averaged about 17.5% of GDP over the same period, and are currently a bit less than 17%. 

Note also that revenues have been a fairly constant share of GDP over the past 50 years, while income tax rates have been all over the map. Trump's 2018 tax cuts occurred at a time when revenues were about 16% of GDP, and since then they have surged both in real and nominal terms. Cutting tax rates does not necessarily add up to lost revenues. On the contrary, setting tax rates at lower and more reasonable levels can end up boosting tax revenues by stimulating investment and boosting the economy's productivity.

Chart #4

Today's edition of Steve Moore's Hotline (see bullet point #2) makes an important point which should be added to this discussion. "... even if you taxed every penny of income earned by millionaires, it wouldn't be enough to close the deficit." That refers to the current deficit, not the total debt owed to the public, which is closing in on $30 trillion. 

Steven Hayward, one of the contributors to the excellent Powerline blog, notes that it is NOT true that "the rich enjoy lower tax rates than the middle class." In fact, "The rich already pay higher federal tax rates. Those with higher income pay a larger share of the tax burden than their share of national incomes.”

UPDATE (10/23/24): Chart #5 below provides proof for my assertion above ("Cutting tax rates does not necessarily add up to lost revenues.)

Chart #5

A close look at Inflation and interest rates

Headline inflation numbers are a bit higher than the Fed's target, but that's entirely due to the way shelter costs are estimated. On balance, it's clear that the Fed has brought inflation back down to acceptable levels. 

Relative to ex-shelter inflation, interest rates remain quite high, especially mortgage rates. The Fed has plenty of latitude to lower short-term interest rates, and I expect another cut in November.

Chart #1

Chart #1 looks at the headline measure of the CPI as well as the ex-energy version, both measured over a rolling 6-mo. annualized basis. Note how much less volatile inflation is when you subtract energy prices. These two measures currently are straddling the Fed's 2% target. Notably, the total (headline) CPI is up at only a 1.6% annualized rate in the past six months.

Chart #2

Chart #2 compares the total CPI to the CPI less shelter version, both on a 6-mo. annualized basis. Here we see that both measures currently are below the Fed's 2% target. Notably, the ex-shelter version is only up at a 0.1% annualized rate! If it weren't for the BLS's faulty measurement of shelter costs, which greatly overstates housing inflation, inflation would be essentially ZERO. 

As I've noted many times in the past year or so, shelter cost inflation has been high and declining slowly (more slowly than I expected). It should continue to decline over the next several months, and that will cause the current gap between total inflation and ex-shelter inflation to narrow.

Chart #3

Chart #3 compares the same two measures as Chart #2, but on a year over year basis. The ex-shelter version of the CPI has been less than 2% in 14 out of the past 17 months, and it currently stands at a mere 1.1%. 

Chart #4

Chart #4 compares the 5-yr Treasury yield to the year over year change in ex-energy inflation. I like to use this version of inflation, because as noted in #1 above, energy is far more volatile than any other component of the CPI. Here we see that interest rates tend to move with inflation, but with a noticeable lag. And with ex-shelter inflation now at 1.1% (note the blue asterisk at the bottom right-hand corner of the chart), there is plenty of room for Treasury yields to decline.

Chart #5

Chart #5 shows the level of real and nominal 5-yr Treasury yields, plus the difference between the two, which is the market's implied inflation forecast for the next 5 years. Inflation expectations currently are about 2.2%, which should please the Fed. Here again we see that there is plenty of room for interest rates to move lower.

As an aside, I note that swap and credit spreads are trading at relatively low levels, which is a sign of abundant liquidity conditions and a healthy outlook for corporate profits. Economic conditions in general are healthy, but I continue to worry about the housing and property markets, which are burdened by very high interest rates and high prices. 

Chart #6

Chart #7 shows the level of 30-yr fixed mortgage rates and the 10-yr Treasury yield, plus the spread between the two. Mortgage spreads currently are quite wide (about 225 bps), compared to where they trade in normal conditions (about 150 bps). This wider-than-normal spread is largely driven by investor's reluctance to buy mortgages when the risk of refinancings is high. People realize that interest rates are high relative to inflation, and they understand also that lower interest rates would spark a wave of refinancings of mortgages that have closed in the past two years. In other words, the perceived downside risk of mortgage bonds is uncomfortably high, and that is depressing the prices of mortgage bonds. If anything this means that while lower mortgage rates are likely in the offing, rates are likely to come down slowly. That will keep downward pressure on housing prices in the interim.  

This wasn't a monster employment number

This morning the market was apparently surprised by a stronger-than-expected jobs number. Private payrolls rose by 223K in September, vs. an expected gain of 125K. Some called it a "monster" number. From my perspective, however, nothing changed at all. Private sector jobs are growing by about 1.3 to 1.4% per year, as they have been for the past several months. This is moderate growth, probably enough to deliver overall economic growth of 2% per year or so. A nothing-burger.

Chart #1

Chart #1 shows the year over year change in private sector jobs, the only ones that really count. The big story, really, is the huge deceleration in growth over the past few years, followed by relatively moderate and steady growth in recent months. Even if we looked at jobs growth over a 6-month period, the story would be the same. Jobs numbers are very volatile on a monthly basis, so you have to look at growth over a multiple-month basis. And when you do that you see that nothing much has changed of late. 

There is nothing in today's report that should influence the Fed to change course. Inflation is yesterday's problem, and jobs growth is moderate. Lower interest rates are appropriate.

Looking pretty good: M2, GDP and corporate profits

I'm certainly not an apologist for the Biden administration, but as the charts below show, the economy on balance has done pretty well in the past several years. The monetary source of the Big Inflation of 2021-2022 has been largely extinguished, real economic growth has exceeded expectations, and corporate profits have been fairly spectacular. 

Chart #1

Recent revisions to the GDP statistics showed the economy posting better than 2.3% annual growth over the past several years (see Chart #1). Of course, this is still far less than it might have been had the economy tracked the 3.1% annual growth path that began in 1966 and continued through 2007. But, considering that many observers were predicting a recession in 2023, economic growth has been surprisingly strong. My own forecast of growth in recent years called for growth slightly in excess of 2% per year, and I am pleasantly surprised to have been too cautious, albeit much more optimistic than most. 

Chart #2

Chart #2 shows the level of the M2 money supply. The huge bulge in M2 tracks the massive government stimulus payments in 2020 and 2021 that were essentially financed by money printing. With a delay of about a year, some $6 trillion of monetary "stimulus" subsequently turned into raging inflation in 2021 and 2022. The Fed was unfortunately slow to react, but by late 2022 they had raised rates by enough to neutralize excess M2 and thus slow inflation. 

Chart #3

Chart #3 is key to understanding the interaction between excess money and inflation. A $6 trillion surge in deficit-financed government spending was not initially inflationary, because the demand for money (which is proxied by the ratio of M2 to nominal GDP in in the chart) surged. That was the logical result of handing tons of cash to a public that had little desire and even less ability to spend it during the lock-down phase of the Covid disaster. But life began to return to normal in early 2021, and the public started to spend the money (i.e., money demand fell). The problem, of course, is that extra spending collided with supply-chain shortages and rising prices were the result. Money demand has almost returned to its pre-Covid levels now, the economy has resumed a more normal growth path, and inflation has become a non-issue for at least the past year. 

Chart #4

Chart #4 compares the level of corporate profits (after-tax, and ex Fed profits) with nominal GDP. 

Chart #5

As Chart #5 shows, profits are at all-time record levels compared to the size of the economy, and they began their current surge (briefly interrupted by Covid) in 2019, following Trump's 2018 reduction in the tax rate on corporate profits from 28% to 21%. Since the end of 2018, corporate profits (after-tax and adjusted for continuing operations and ex-Fed profits) have risen 58%, while nominal GDP rose 39%. Despite the sizable cut in tax rates, corporate tax payments to Treasury rose from a low of $189 billion in the 12 months ending Jan. '19, to $516 billion in the 12 months ending August '24—a whopping increase of 173%! And, not surprisingly, the S&P 500 is up 130% since 2018. 

Art Laffer, take a bow!

While it's great to see evidence that what's good for corporations is also good for the economy, there's a cautionary message here. If, as they have repeatedly promised, a Harris-Walz administration allows the Trump tax cuts to reverse as scheduled at the end of next year, this could pose a significant threat to the economy and, by extension, the stock market. 

Please excuse the absence of posts this past month. I haven't had much to say, and I needed a break. Plus, we had a delightful trip to Greece.

Kamala's tax proposals: frightening!

If you subscribe to my good friend Steve Moore's daily Hotline (subscribe for free here), you have already seen this. I reprint it so as to maximize its distribution. These proposals are so astoundingly anti-business and anti-prosperity that I can't imagine they will ever see the light of day. But at the very least you have here a liberal wish-list that, if even partially enacted, would very likely eviscerate the economy. Click here for more background info.

Kamala Proposes $5 Trillion in New Taxes – the Biggest Tax Hike in the History of the World

We've argued that Harris-Walz is the most anti-business ticket by a major presidential party in our lifetimes and perhaps in American history. And we said this BEFORE we saw the new tax plan.  Instead of lowering tax rates to make America more competitive, it raises nearly everyone. The Harris tax plan would: Raise the corporate tax from 21% to 28% Quadruple the tax on stock buybacks from 1% to 4% Double the global minimum tax from 10% to 20% Raise the top Income tax rate from 37% to 39.6% Raise the corporate alternative minimum tax from 15% to 21% Raise the capital gains tax from 24% to 43.5% Impose the first-ever tax on unrealized capital gains at 25% Double the number of Americans subject to the death tax

+ The compounding effect of these multiple tiers of taxation would mean that a $100 investment in a new company could be subject to an 80% tax rate.

Excess M2 continues to fade away

Long-time readers of this blog know that I have been one of only a handful of observers who have linked excessive M2 growth (i.e., money printing) to the big inflation problem that hit the US economy beginning in the first part of 2021. (Here is one of my first posts on the subject in Feb. '21.) I continue to believe that excessive M2 growth was the biggest story that virtually no one—especially the Fed—paid any attention to, until it was too late. Fortunately, this problem began fading away two years ago, and it continues to do so.

It took the Fed a full year before they began to tighten policy, and as I see it, they could have begun to ease at least a year ago, but we now know they won't begin to cut rates until the mid-September FOMC meeting. Better late than never, I suppose, but their tardiness risks destabilizing the interest-sensitive sectors of the economy, particularly housing. In the meantime, the monetary fundamentals support the outlook for continued low inflation.

Chart #1

The M2 measure of the money supply grew at a fairly constant rate of 6% per year from 1995 through 2019. Then it exploded higher beginning in April 2020 as $6 trillion of Covid "stimulus" checks flooded the economy. Once the dust had cleared by late 2021, an extra $6 trillion of deficit spending had been monetized and was sitting in the form of readily spendable currency, bank deposits, and checking accounts (all components of the M2 money supply). This was the fuel for rising prices in 2022.

As Chart #1 shows, M2 has been flat to down since late 2021. It rose a mere 1.3% in the 12 months ending July '24 (according to the latest figures from the Fed, released earlier today). The monetary situation is almost back to normal, as M2 today sits only $1.6 trillion above its long-term trend growth.

Chart #2

Chart #2 compares the growth in M2 with the level of the federal budget deficit. This chart is the smoking gun which proves that the source of our great inflation episode was deficit-fueled spending. Fortunately, deficit spending is no longer being monetized; unfortunately, we still have a monstrous deficit spending problem. Deficits are primarily the result of excessive government spending, and that weakens the economy because it wastes scarce resources.  

Chart #3

Chart #3 compares the growth of M2 to CPI inflation with a one-year lag. Roughly speaking, increases in M2 growth are followed by increases in inflation one year later. This chart suggests that we have another year or so of low and falling inflation "baked in the cake," thanks to very low money growth in the past year. 

Chart #4

Chart #4 shows the ratio of M2 to nominal GDP. I think this is the best way to measure money demand. Think of it as a proxy for the amount of spendable money (cash, checking accounts, bank savings accounts, CDs, and retail money market funds) that people want to hold as a percent of their annual income. (Nominal GDP is an excellent proxy for national income.) Money demand soared in 2020, and that kept trillions of dollars of newly-minted M2 from creating inflation. It then collapsed, and that caused people to spend the money they had previously stockpiled. Extra demand fueled by unwanted money collided with supply-chain shortages to produce sharply higher prices.

I suspect that money demand is approaching sustainable levels, just as excess money supply (M2) is shrinking. That is a prescription for low and stable inflation. 

Mortgage rate relief is coming

The minutes of the July 31st FOMC meeting released today tell us it's now virtually certain that the Fed will cut rates at the September 18th FOMC meeting. The only question is by how much. The market has already priced in a cut to 5.0%, and 4.8% is not out of the question at all—the market expects the funds rate to fall 200 bps over the next 12 months. Thanks to these anticipated cuts, the 10-yr Treasury yield has fallen to 3.8%, down significantly from a high of 5.0% last October. 30-yr fixed mortgage rates—which are driven primarily by the 10-yr Treasury yield—have fallen from a high of 7.8% last October to just under 6.5% today.

But as the chart below shows, the spread between these two rates is still quite high from an historical perspective. That's due in part to the extreme volatility of 10-yr yields in the past few years. Investors need extra spread protection in this environment in order to buy mortgages, since falling yields trigger refinancings (which turn long-dated mortgage bonds into cash) and rising yields encourage homeowners to avoid refinancings (which leaves the investor saddled with a low-yielding fixed rate mortgage in a rising rate environment). When rates are relatively calm, as they were in the mid 2010s, the spread traded around 150 bps; today it is over 250 bps.

What I would expect to see is 10-yr yields settling down in a 3.5-4% range, and mortgage spreads tightening to 150 bps or less. That would put 30-yr mortgage rates at around 5-5.5%. And that would give a huge boost to the struggling housing market because it would make homes much more affordable.

GDP, jobs, money, and inflation overview

The past several weeks were spent on a family vacation in Maui, and it was wonderful. Maui is definitely back in business—we have never been so warmly received!

So it's time to resume posting. It's been a month, but my outlook hasn't changed. I still think that the Fed has done enough to tame inflation, which, if measured correctly, is running comfortably within the Fed's target range. The economy is growing at an unspectacular pace, with risks slightly skewed to the downside (but no signs of a recession). Most importantly, financial liquidity conditions are strong, and the outlook for corporate profits remains healthy.

Political risks probably outweigh economic risks at this point. Harris and Trump appear to be running neck-to-neck, and both espouse economic policies that are troubling. Trump is fixated on tariffs, while Harris is fixated on price controls, and either one would hamstring the economy. As much as I dislike Trump's current stance, his intelligence and executive experience clearly "trump" Harris', and the political leanings of Harris and Walz are way too far to the left for my taste. In any event, I can't imagine Harris will survive close scrutiny, and she could easily implode as did Biden in his debate with Trump. 

Chart #1

As Chart #1 shows, the US economy has been growing at about a 2.2% annual rate since mid-2009. No boom or bust is yet in sight.

Chart #2

Chart #3

Private sector jobs growth (Chart #2) has been slowing for the past two years. At the current rate of about 1.5% per year, this is not enough to deliver overall growth of more than 2% or so (as Chart #3 suggests).

Chart #4

M2 growth continues to slow as well, as Chart #4 shows. The huge bulge in M2 was the by-product of $6 trillion of fiscal "stimulus" doled out by the Trump and Biden administrations, and it was in turn the proximate cause of the inflation bulge. Both are now in the past, and monetary conditions continue to return to some semblance of "normal."

Chart #5

I have argued for years now that the behavior of money demand and money supply easily explain the rise in inflation which began in early 2021 and which peaked in mid-2022. The initial surge in money was offset by an equal surge in the demand for money, which is why inflation didn't surge until early 2021. But after that, and as the economy got back on its feet post-Covid, the demand for money (Chart #5) collapsed. The public began spending the money that had been stockpiled during the Covid shutdowns, and it was a classic case of too much money chasing too few goods (which were constrained because of supply-chain shortages). Money demand is now approaching some semblance of normal.

Chart #6

This same dynamic played out with currency in circulation (Chart #6). During the panic of 2020, most people wanted extra cash in their pockets if for no other reason than that it was difficult to spend it. That has completely reversed. The ratio of currency in circulation to nominal GDP is now less than 1% higher than it was prior to the onset of Covid lockdowns.

Chart #7

Chart #7 shows the spread between investment grade and high-yield corporate debt and Treasuries, which is an excellent barometer of the market's expectations for future profits (lower spreads being good). The current level of spreads also suggests that financial market liquidity is abundant, and that in turn reflects confidence in the health of the economy.

Chart #8

Chart #8 shows the level of Bloomberg's financial conditions index, which uses a variety of money market inputs to gauge the overall health of the financial markets. Conditions appear to be substantially normal here as well, with no signs of distress.

Chart #9

Chart #9 shows the level of the Producer Price Index, which measures inflation pressures early in the production pipeline. As should be evident, there has been zero inflation according to this measure since mid-2022. In fact, the price level according to this measure has actually fallen by 0.9% since June '22, when inflation peaked. 

Chart #10

The Consumer Price Index rose 2.9% in the year ended July '24, but roughly one-third of that increase came from shelter costs (as I've explained repeatedly over the past year or so). Chart #10 shows the changes in the CPI and the ex-shelter version of the CPI, the latter of which has increased by 1.78% in the past year and only 1.45% annualized over the past two years. 

Moreover, the CPI is up at an annualized rate of only 0.4% annualized in the past three months, while the ex shelter version has fallen at an annualized rate of -1.5%! 

Chart #11

Chart #11 shows the three major components of the Personal Consumption Deflator, arguably the best measure of inflation at the consumer level. What stands out here is that, since the inflation peak of mid-2022, prices of durable goods have declined, and prices of non-durable goods have risen by a mere 0.9%. Substantially all of the measured inflation in the past two years comes from "services," which are in turn dominated by shelter costs.

Chart #12

Chart #12 compares 5-y Treasury yields to the ex-energy version of the CPI (I use this measure because energy prices have been extraordinarily volatile in the past two decades). Note the blue asterix at the bottom right hand side of the chart, which marks the year over year change in the CPI ex-shelter (1.78%). At this level of inflation, and based on past relationships, a 5-yr Treasury yield of between 2% and 3% would not be unreasonable at all.

I see no reason for the Fed to delay a move to lower interest rates substantially. 

How bad is fiscal policy?

It's no secret that federal debt is bigger, relative to the economy, than at any time since WW II, that deficits these days are measured in trillions, and that interest on the debt likely exceeds spending on defense. It's unquestionably bad. But is it out of control? Not yet.

To begin with, Federal Debt Owed to the Public is $27.7 trillion. It's not $34.9 trillion, as many will tell you. The latter figure is Total Public Debt Outstanding, but that includes $7.2 trillion of Intergovernmental Holdings. Those holdings are debt that one part of the government owes another (most of it is owed to Social Security). But to include that in the total is double-counting. Social Security surpluses are "invested" in Treasuries, and in this manner Social Security surpluses effectively reduce Treasury's need to sell bonds to finance the larger government deficit. 

Knowing how much the federal government owes to the world is one thing, but the burden of the debt is quite another. The burden of the debt depends on the level of interest rates and the nominal size of the economy. Today the debt is huge relative to the size of the economy, but interest rates are relatively low, with the result that the burden of the debt today is much less than it was in the 1980s, when federal debt was about 40% of GDP, thanks to interest rates today being much lower than they were in the 80s.

Here are some charts that put deficits and debt into perspective.

Chart #1

Chart #1 is a history of federal debt owed to the public from 1970 through July '24. It's plotted on a logarithmic axis, thanks to which a constant rate of growth shows up as a straight line. It's commonly thought that federal debt has been surging at unprecedented rates in the past 5 or so years, but that's not true. Debt grew at a much faster rate in the mid-1980s. For the past 75 years, our national debt has increased on average by about 8.8% per year, and recent years have proved to exception.

Chart #2

Another common misperception about our national debt is that more debt should push interest rates higher, and less debt should allow interest rates to decline. As Chart #2 shows, the relationship is often just the opposite. The peak in bond yields occurred in the early 1980s, when debt relative to GDP was very small and was growing rapidly. In the 2010s, debt was surging relative to GDP and interest rates collapsed. Lots of debt in the 1940s occurred during a period of low and relatively stable interest rates. As a general rule of thumb, interest rates are not determined by the amount of debt, but rather by the level of inflation and the strength of the economy.

Chart #3

Chart #3 shows the source of our national debt—the difference between spending and revenues. Is our deficit the result of it too much spending or not enough revenues? That, like beauty, is in the eye of the beholder. One thing for sure, however, is that the government chronically spends more than it takes in.

Chart #4

Chart #4 helps answer the question from another perspective, by comparing spending and revenues to the size of the economy. The dashed lines on the chart show the post-War averages for each. Since the mid-00s, spending has been much higher than its post-war average, whereas revenues have been generally closer to their long-term average. This suggests that spending is the problem.

Chart #5

Are revenues too low because tax rates are too low these days? Could higher tax rates boost revenues as a percent of GDP? Not necessarily! According to Chart #5, it seems that federal revenues are not at all a function of the level of tax rates. Reagan slashed tax rates in the early 1980s, but tax revenues proceeded to surge relative to the size of the economy in subsequent years—because the economy enjoyed a surge of growth. Isn't it better to achieve a given level of revenues with lower tax rates than with higher tax rates? Taxes distort behavior and weaken the economy. At the same time, government spending tends to be much less efficient than private sector spending. 

Chart #6

What about the source of federal revenues? As Chart #6 shows, the individual income tax generates about half of federal revenues these days. Payroll taxes account for 34%, corporate taxes about 11%, and estate and gift taxes 0.6%. If I could eliminate only one tax, it would without question be the Estate and Gift Tax. Last year it generated only $30 billion, which was about 0.6% of federal revenue. $30 billion is pretty much a rounding error when it comes to government finances. Yet the Estate and Gift Tax has a profound impact on the economy: the ultra rich spend massive amounts of money hiring accountants and lawyers to find a way around paying the tax, and very few pay anything in the end. But small business and family farms are often forced to liquidate in order to pay the tax. And of course it amounts to double-and triple and even quadruple taxation for many, since any money saved and invested must first pay income tax. 

Chart #7

Chart #7 shows the true burden of our federal debt: interest payments on the debt as a percent of GDP. The debt burden was 25-30% higher in the 1980s than it is today. True, the debt burden is likely to continue to climb, especially if interest rates rise. But if they fall, as the Fed has all but conceded they will, then our debt burden should remain within bearable levels for the foreseeable future.

One important thing is missing from almost every discussion of debt and debt burdens: the burden of the debt from the government's perspective is equal to the payouts received by all those who have purchased Treasury securities. One man's debt is another man's asset. Paying interest on our national debt is not like flushing money down the toilet. In fact, the true cost of the debt can only be calculated by considering the benefits the country has obtained by issuing debt. A business can issue tons of debt and still grow, provided it is using the money raised for productive purposes. But governments—especially ours in recent years—are notoriously inefficient in that regard. (As I noted here, our government is spending an enormous amount of money on transfer payments, which for the most part only fund spending, not investment.)

And this leads to another conclusion: the problem with debt and deficits is not the borrowing, it is the spending that created the deficits in the first place. 

Who spends money better: the person who spends his own money, or the person who spends other people's money?

Chart #8

Chart #8 shows the federal budget deficit as a percent of GDP over time. The nominal amounts at key points are highlighted in green text. Note some amazing things: today's deficit is just about as much relative to GDP as was the deficit in 1983, but in nominal terms, today's budget deficit ($1.6 trillion) is 8 times larger than 1983's deficit!