The US government's borrowing binge could have disastrous consequences. Interest payments are projected to surpass defense spending this year, and a record debt mountain casts a long shadow over the nation's future. Buckle up, investors and taxpayers, the road ahead might be bumpy.
Treasury yields are soaring, reflecting investor concerns about the mounting debt pile. Rising interest payments gobble up resources meant for other crucial areas, putting pressure on the budget and raising fears of economic slowdown. While markets haven't fully panicked yet, here's why investors are nervously watching.
The pandemic pushed interest rates to zero and triggered a borrowing bonanza. The Treasury issued a record $23 trillion in bonds last year, and now faces the steep price of paying off that debt as the Fed hikes rates. Expecting to spend nearly double the historical average, America's interest tab is set to reach a staggering 3.9% of GDP by 2034.
Rising debt can actually stimulate economies, up to a point. More borrowers create more lenders, and bonds function as vital assets. Defaulting on US debt is unthinkable – Treasurys are the bedrock of global finance, and the dollar remains the world's reserve currency.
Investors are bracing for a "new normal" of larger deficits, which could eventually strain the economy and financial markets. As Campbell Harvey, a renowned finance researcher, warns, "The debt will become a problem, but pinpointing the exact moment is tricky."
The government borrows by issuing bonds, and a larger deficit demands even more issuance. This supply glut could force investors to demand higher yields, driving down bond prices. Ultimately, higher borrowing costs for mortgages, business loans, etc., could stifle economic growth as consumer spending and investments dwindle.
A robust economy has fueled record highs for stocks, but prolonged slow growth triggered by debt woes could hammer corporate earnings and stock prices. As interest costs climb, the government needs to issue more debt, further escalating the spending cycle and exacerbating the problem.
The Congressional Budget Office projects a mind-boggling scenario: by 2034, public debt could balloon to $48 trillion, more than eight times the 2008 level. This would represent a staggering 116% of GDP, far exceeding the current 97%. As Lee Ferridge, a seasoned macro strategist, puts it, "Higher deficits translate to higher interest rates, which ultimately mean lower growth and asset values."
Stocks and bonds witnessed a wobble last summer when the Treasury surprised markets with unexpected bond issuance. However, markets bounced back after adjustments were made. Investors' renewed appetite for debt is evident in the stabilizing 10-year Treasury note yield, currently hovering around 4.2%.
Increased issuance and fiscal spending can indeed provide an economic boost, benefiting riskier assets like stocks. However, the critical question remains: when does debt become a drag on the economy? Some experts fear it could hamper the government's ability to stimulate the economy during recessions.
There are no easy fixes for this predicament. Cutting spending might hurt jobs and slow growth, while raising taxes carries the risk of dampening economic activity. Politically unpopular decisions make significant fiscal changes unlikely, regardless of the November election results.
Even if tighter fiscal policy is implemented, a recession could trigger automatic stabilizers, leading to falling tax revenues and, guess what? Larger deficits.
