How soon will the US national debt be unaffordable?

It is time to look again at a subject which has been a regular topic in the comments section. This is what happens when national debt costs start to rise again? We have spent a period where rises in national debts have been anesthetized by the Quantitative Easing era where central bank purchases of sovereign debt have had a side effect of reducing debt costs in some cases by very substantial amounts. Of course  it is perfectly possible to argue that rather than being a side effect it was the real reason all along. Personally I do not think it started that way but once it began like in some many areas establishment pressure meant that it not only was expanded in volume but that it has come to look in stock terms really rather permanent or as the establishment would describe it temporary. Of the main players only the US has any plan at all to reduce the stock whereas the Euro area and Japan continue to pile it up.

So let us take a look at projections for the US where the QE flow effect is now a small negative meaning that the stock is reducing. Here is Businessweek on the possible implications.

Over the next decade, the U.S. government will spend almost $7 trillion — or almost $60,000 per household — servicing the nation’s massive debt burden. The interest payments will leave less room in the budget to spend on everything from national defense to education to infrastructure. The Congressional Budget Office’s latest projections show that interest outlays will exceed both defense discretionary spending and non-military discretionary spending by 2025.

The numbers above are both eye-catching and somewhat scary but as ever this is a case of them being driven by the assumptions made so let us break it down.

US National Debt

It is on the up and up.

Debt held by the public, which has doubled in the past
10 years as a percentage of gross domestic product
(GDP), approaches 100 percent of GDP by 2028 in
CBO’s projections.

Those of you who worry we may be on the road to World War III will be troubled by the next bit.

That amount is far greater than the
debt in any year since just after World War II

As you can see the water has got a bit muddled here as the CBO has thrown in its estimates of economic growth and debt held by the public so let us take a step back. It thinks that annual fiscal deficits will rise to above US $1 Trillion a year in this period meaning that from now until 2028 they will total some US $12.4 billion. That will put the National Debt on an upwards path and the amount held by the public will be US $28.7 Trillion. Sadly they skirt the issue of how much the US Federal Reserve will own so let us move on.

Deficits

These have become more of an issue simply because the CBO thinks the recent Trump tax changes will raise the US fiscal deficit. The over US $1 Trillion a year works out to around 5% of GDP per annum.

Bond Yields

These are projected to rise as the US Federal Reserve raises its interest-rates and we do here get a mention of it continuing to reduce its balance sheet and therefore an implied reduction in its holdings of US Treasury Bonds.

Meanwhile, the interest rate on 10-year Treasury notes increases from its average of 2.4 percent in the latter part of 2017 to 4.3 percent by the middle of 2021. From 2024 to 2028, the interest rate on 3-month Treasury bills averages
2.7 percent, and the rate on 10-year Treasury notes,
3.7 percent.

Currently the 10-year Treasury yield is 2.83% so the forecast is one to gladden the heart of any bond vigilante. If true this forecast will be a major factor in rising US debt costs over time as we know there will be plenty of new borrowing at the higher yields. But here comes the rub this assumes that these forecasts are correct in an area which has often been the worst example of forecasting of all. For example the official OBR forecast in the UK in a similar fashion to this from the CBO would have UK Gilt yields at 4.5% whereas in reality they are around 3% lower. That is the equivalent of throwing a dart at a dartboard and missing not only it but also the wall.

Inflation

This comes into the numbers in so many ways. Firstly the US does have inflation linked debt called TIPS so higher inflation prospects cost money. But as they are around 9% of the total debt market any impact on them is dwarfed by the beneficial impact of higher inflation on ordinary debt. Care if needed with this as we know that price inflation does not as conventionally assumed have to bring with it wage inflation. But higher nominal GDP due to inflation is good for debt issuers like the US government and leads to suspicions that in spite of all the official denials they prefer inflation. Or to put it another way why central banks target a positive rate of consumer inflation ( 2% per annum) which if achieved would gently reduce the value of the debt in what is called a soft default.

The CBO has a view on real yields but as this depends on assumptions about a long list of things they do not know I suggest you take it with the whole salt-cellar as for example they will be assuming the inflation target is hit ignoring the fact that it so rarely is.

In those years, the real interest rate on
10-year Treasury notes (that is, the rate after the effect of
expected inflation, as measured by the CPI-U, has been
removed) is 1.3 percent—well above the current real rate
but more than 1 percentage point below the average real
rate between 1990 and 2007.

Economic Growth

In many ways this is the most important factor of all. This is because it is something that can make the most back-breaking debt burden suddenly affordable or as Greece as illustrated the lack of it can make even a PSI default look really rather pointless. There is a secondary factor here which is the numbers depend a lot on the economic impact assumed from the Trump tax cuts. If we get something on the lines of Reaganomics then happy days but if growth falters along the lines suggested by the CBO then we get the result described by Businessweek at the opening of this article.

Between 2018 and 2028, actual and potential real output
alike are projected to expand at an average annual
rate of 1.9 percent.

The use of “potential real output” shows how rarefied the air is at the height of this particular Ivory Tower as quite a degree of oxygen debt is required to believe it means anything these days.

Comment

The issue of the affordability forecast is mostly summed up here.

CBO estimates that outlays for net interest will increase
from $263 billion in 2017 to $316 billion (or 1.6 percent
of GDP) in 2018 and then nearly triple by 2028,
climbing to $915 billion. As a result, under current law,
outlays for net interest are projected to reach 3.1 percent
of GDP in 2028—almost double what they are now.

This terns minds to what might have to be cut to pay for this. However let me now bring in what is the elephant in this particular room, This is that if bond yields rise substantially pushing up debt costs then I would expect to see QE4 announced. The US Federal Reserve would step in and start buying US Treasury Bonds again to reduce the costs and might do so on a grand scale.. Which if you think about it puts a cap also on its interest-rate rises and could see a reversal. Thus the national debt might remain affordable for the government but at the price of plenty of costs elsewhere.

 

 

 

 

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20 thoughts on “How soon will the US national debt be unaffordable?

  1. Hi Shaun
    All of these long term projections seem arbitrary rather than
    reasoned so “Were on the road to nowhere.”
    The reality must surely be, that eventually one of the many
    bubbles will burst and then who knows what will happen, I just hope
    that I will still be alive to see it.
    “Inflation is when you pay fifteen dollars for the ten dollar
    haircut you used to get for five dollars when you had hair.” – Sam Ewing.

    JRH

    • Hi JRH

      Your point on the assumptions is well made as what happens depends as much on them as anything. These sort of things do have a use as a sort of benchmark but the mainstream media takes them far too seriously. After all has one ever forecasted a new recession?

  2. One of the curiosities about budget discussions in the UK (and the USA) is that the interest bill very rarely gets talked about. It is as though this is some cost that arrived from outer space and must be paid. When I become chancellor (relax, no time soon), I will be publishing:
    1. A daily debt counter like the US one in New York;
    2. Comparisons of the interest burden in each budget year to real things like the NHS/defence/schools etc
    I would also point out that QE, while sounding very complicated, is
    1. Distorting interest rates, with the knock-on effect of trashing the value of pensions
    2. Just another way of politicians to spend money and pretend no one has to pay for anything.
    I am convinced that, when Mr Corbyn gets into power, he will realise that QE IS a magic money tree, will force the BoE to jack it right up and spend what he likes. He will then be a hero for giving everyone everything free and, if it all goes pear-shaped, he can blame insidious capitalism for destroying itself.
    I am off to lie down

  3. Great blog as usual, Shaun.
    As you say, the US has more measures of inflation than it needs. When the BLS decided its wage-earner target population was too narrow, they brought in the CPI for the urban population (CPI-U) but they kept the CPI-W around, and both are used for upratings. The chained CPI (C-CPI-U) is better than either since it virtually eliminates upper level substitution bias. The CPI-U could have been converted to a chained CPI after the C-CPI-U had been tested for a while. Instead we get yet another CPI. Paul Ryan, the House Speaker who just announced he won’t be running for re-election this year, is a champion of making the C-CPI-U or chained CPI the escalator for Social Security. His justification of it in April 2013 was admirable: “I don’t see this as fundamental entitlement reform as much as clarifying a statistic which does happen to save money,” In fact, it would save a lot of money: the 2013 Bowles-Simpson plan estimated it would save about $280 billion over a decade. The recent tax reform package, which made the chained CPI the escalator for income tax brackets, was a step in the right direction, but the tax savings from doing this are only about a third of what they would be from doing the same thing for Social Security. Let’s hope that Ryan’s successor can complete the switch to a chained CPI, which Ryan started.
    Carney spoke on Jersey Day in Canada yesterday, when everybody was asked to wear a hockey jersey in sympathy with the Humboldt Broncos. It didn’t seem that a single person in the audience was wearing a jersey for Carney’s speech, including Carney, who played hockey on a university team. It didn’t seem right to me. If there was a dresss code for the event it should have been waived.
    https://www.tsn.ca/nhl/video/tom-cochrane-performs-in-tribute-to-humboldt-broncos~1352123

    • Hi Andrew and thank you

      I have no great objection to the globe trotting of the present Governor of the Bank of England especially when he visits no doubt what he still considers home. My problem is the apparent disconnect between that and his speeches on climate change.

      • Shaun, his wife is a raving green nutter. Also he has just chaired the BIS committee deciding how CBs and commercial banks will include CC risk in EVERY investment decision. He has helped bake into the system impoverishment for vast swathes of the earth’s population.

  4. Hi Shaun

    The difference between the interest cost in 2017 and that in 2028 is $600bn which just happens to be the current US defence budget. If the US were serious about drawing back from foreign adventures and took serious steps to lower the temperature in international relations then a substantial amount could be saved by spending less on defence. However, I can’t see this with Trump and even a relative pacifist such as Obama bombed six countries in 2016 as the World’s policeman.

    Grover Norquist has gotten the vast majority of the Republicans to sign the American Tax Pledge so I can’t see any substantial new taxes to bridge the gap here.

    Folk like Alan Greenspan have talked about reigning in “entitlements” by which they mean Pensions, Medicaid and Medicare but I think this would cause great difficulties with many of the populace and won’t come about. This might well be a pitchforks and barricades issue if it was attempted.

    Looking at the practical and likely, like you I think it’ll be QE4 or QE infinity. But this will only monetize the debt, destroy the dollar and ultimately push inflation up to potentially very high levels with very destructive consequences. These issues are getting to be of a size where the only solution is a reorganization of the social and economic system and there are too many vested interests to allow this on a peaceful basis. I would say go long on tin hats and baked beans.

    • Hi Bob J

      We do seem to be in a trap where it is both difficult to raise taxes ( the National Insurance changes for the self-employed in the UK come to mind) and the major sources of expenditure only seem to rise. In short the economy had better grow which is the view in a way of the central banks as we return to QE4 (5…6) which as you say will blow up in the end.

  5. I think that the real problem is that TPTB have decided that money’s only competence is for it to be used as a method of exchange, and no longer an arbiter, or store, of wealth.
    This is, imv. because the elite have used currency to accumulate such an overwhelming majority of assets, and the best way to keep them, is to make them unaffordable for the rest.
    Hence we have just about every asset possible supported by central banks, which has, in real terms, caused such huge asset inflation over the past 4 decades, that shelter becomes a luxury.
    Climate subsidies add such cost to fuel prices that heat becomes a luxury:
    https://climatechangedispatch.com/48000-brits-dead-after-worst-winter-in-42-years/
    Food prices far above real inflation plus shrinkflation too.
    Money is devaluing all the time and TPTB don’t have any want or need for its integrity, hence, printy, printy.

    • Hi therrawbuzzin

      What you say is of course why the establishment are so keen on wealth effects as for them higher asset prices are exactly that. That sort of thought brings to mind the story about Jeremy Hunt that emerged today. From the BBC.

      “The Telegraph said Mr Hunt set up Mare Pond Properties in 2017 to buy seven flats in the Ocean Village development in Southampton.”

      For those with little or no assets then the price rises are inflationary pure and simple.

  6. As Shaun says, if bond yields spike, expect QE4 to be announced, I have said the same thing numerous times, they have no other option, Bernanke point blank denied the first three iterations of QE were money printing or monetisation, as the debt could be cancelled as quickly as it was
    created, and they had it under control(just like they had the housing bubble under control before it burst).Charles Ponzi would no doubt be proud his work has now been adopted by central banks worldwide and given official recognition.

    If they announce QE4, how will it ever be paid back? it will have to be many times larger in size than the previous QE versions, and will be paid back/rolled over by subsequent issues of freshly printed QE(to infinity and beyond) money and it will be obvious to even the slowest HFT computer or human trader that now the Fed is totally trapped in a never ending and escalating cycle of monetising the US governmant debt, after all, what incentive is there for politicians to act or spend responsibly when the Fed is paying every increase in spending with “free” money?Each time though, will require ever more bigger purchases as the stimulative effect will wane with each attempt, and the time the stimulus lasts will get smaller and smaller, but by then the $ will be being dumped and will be in freefall. Think “Round The World in Eighty Days”, when they ran out of coal on the way to London and started breaking up the ship to fuel the boilers.

    This was all predicted by Peter Schiff and Marc Faber when QE started, Faber quipped it will be QE99 when asked when it would end,and also Mitch Fierstein who wrote the book “Planet Ponzi”, he famously said of QE tapering – “You cannot taper a ponzi scheme”, there is only one outcome – an inflationary currency collapse, the only unknown is how long it will take.Expect pleny of double speak from Fed officials, talking tough one minute -QE is ending- then announcing it is re-starting – or called something else – when markets and/or the dollar crash. A bit like Carney’s farce over here really – empty threats.

    • Hi Kevin

      It is my opinion that at least some of the recent US Dollar weakness is due to fears about QE4. Actually an even less debated topic is that QE4 would put a cap on official US interest-rates as there is a problem buying bonds at say 3% if your own interest-rate is say 3.5%. In short if the world economy dips this summer/autumn as seems increasingly possible there is going to be plenty to discuss and analyse.

  7. The US is a Military superpower but it is by any measure on the verge of economic bankruptcy ,how any person can describe it or Japan as a safe haven is beyond delusional or reasonable comprehension.
    It is only getting away with this because of its reserve currency status and the petrodollar.
    Why anybody buys their worthless treasury bonds (iou’s) is beyond me they are paying a measly rate of return in a currency that is constantly losing purchasing power.So they are losing money against fake inflation numbers and losing purchasing power on the principle value of the bond.
    The old adage in criminal investigation is follow the money Iraq stopped using dollars in oil trade and switched to Euros couldn’t be allowed Ghaddafi was working on a similar scheme.
    Russia and China now cutting dollar out of their bilateral trading.
    As stated elsewhere the interest will eventually overwhelm the US and others the currencies will devalue printing to infinity will destroy confidence.
    There is an unfathomable resistance to admitting that our debt based currencies are imploding under the weight of the debt,there needs to be a New Bretton Woods conference.

    • Hi Private Fraser

      I thought of you earlier as I read this on Bloomberg.

      “Standard & Poor’s raised its outlook for Japan to positive from stable, citing healthier economic growth prospects, the credit-rating company said on Friday.

      Nominal growth exceeding 2 percent and negative effective real interest rates would enable relative debt to stabilize sooner than previously anticipated, S&P said. The outlook could return to stable if growth is weaker than expected and fiscal consolidation slows, it said.”

      Meanwhile in other news it emerged that the population had shrunk again for the 7th year in a row. No doubt when it fully impacts we will be told it is a surprise…

  8. I’ve come to the conclusion that debt in many of its forms is not just driven by interest rates (i.e. low rates encourage increases in debt and vice versa), but that in fact, interest rates are driven by debt levels.

    Rates are not known as the “monetary policy transmission mechanism” without reason. It goes that if debts are very large then the smallest of rates (absolute and any incremental changes) have much bigger effects on the economy. Remember when rates were changed by as much as 1% and now they are in slivers of 1% and over much longer periods.

    With specific regard to public debt and the purchasing by the central banks, I don’t know how this is affected. At the very least one could expect spending to come under pressure if rates are higher.

  9. By the way, the only solution we know of is:
    1. to implement much, much higher taxes (think post world war 2), especially on the richest
    2. Move to altering the international trading system to build in balanced trade and limits on capital flows to stop recycling of trade surpluses

    • Hi hotairmail

      Interest-rates did use to change by more than 1% as I recall working in the bedlam of White Wednesday when we were ejected from the ERM. The Base Rate was raised by 2% and another 2% was announced for the next day although it never happened because the game was up by then.

      As to the tax situation we have allowed the wealthy both individual and companies to slip out of the nets haven’t we?

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