Here’s Why Inequality Is Responsible For Soaring US Debt Levels

Here’s Why Inequality Is Responsible For Soaring US Debt Levels
Stéphane Renevier, CFA

3 months ago2 mins

Most people blame soaring US debt on fiscal recklessness, but economist Michael Pettis says it’s more about structural flaws – in particular, rising income inequality. And as long as nothing’s done to reverse it, the US debt will have to keep growing, or Americans will be forced to accept higher unemployment. Here are his thoughts.

Rich folks are saving more, and spending less. So income inequality forces up savings by effectively transferring income from regular spenders (that’s you and me) to big savers (the wealthy). If the increased savings were invested back into the economy, that wouldn’t necessarily be a bad thing. The issue is, that’s not fully happening (and that’s partly because businesses are constrained by weak demand rather than a lack of capital). So all else being equal, those higher savings – and reduced spending – are shrinking the total demand in the economy and leading businesses to cut production and lay off workers.

To tackle this conundrum, Uncle Sam has three potential cards to play. One: make borrowing more attractive to households to sustain consumption levels. Two: dip into America’s own piggy bank to borrow and rev up demand. Or, three: export the savings in the form of a trade surplus.

That third option is out of the question for the US: it’s the world’s go-to place to park excess savings, so it’s stuck being a net importer of those funds. That keeps the US dollar strong, which, in turn, hurts competitiveness and widens trade deficits. But the first two are express trains to higher national debt, and they explain why it’s been soaring. That makes sense: without soaring debt offsetting that lower demand from excess savings, the economy would be weaker and unemployment higher.

The bottom line is that rising US debt is not simply the result of an out-of-control spending binge: it's a structural issue tied to income inequality and trade dynamics. And until those things are tackled, the US is caught between a rock and a hard place, forced to choose between higher debt or more unemployment. Debt ceilings and spending cuts won’t solve the problem. The only way to break this cycle is to rethink the policies that have helped exacerbate inequality.

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