Our national debt is $35 trillion and growing by about $2 trillion per year. We don’t “feel” that number, but we do feel interest on that $35 trillion. Fortunately, for now most of that debt is financed with old Treasury Bonds and Bills, so the current blended interest rate is a little less than 3%. At 3% interest, our current interest expense is a little under $1 trillion per year. That makes it about the same as the spending on national defense, our third largest expense, and it is getting worse.
Interest rates are currently materially higher than 3% so interest expense on our national debt is heading higher as current Treasury loans mature and are replaced with newer loans.
This increasing interest expense will crowd out other government expenses and will become our largest expense when interest on the debt reaches 5%.
Most expect the Federal Reserve to pivot, and reduce interest rates, but this just perpetuates the dilemma shown in the following.
Monetizing
Tax revenues are about $5 trillion per year, which is about $2 trillion less than our annual expense, hence the $2 trillion annual deficit. Greater tax revenues might finance increasing debt. This could happen through strong economic growth and/or higher taxes.
If tax revenues do not increase sufficiently, spending on other items could be cut, but the most likely scenario is increasing deficits – a debt spiral. “Monetizing the debt” is a prescription for hyperinflation.
The other option is pivoting back to a zero interest rate policy (ZIRP), but that is inflationary too because the Fed will have to step in again to buy long-term Treasuries – it will “print” money. Under the current quantitative tightening, the Fed is allowing these bonds to mature without replacement.
Long term bonds won’t clear the market at ZIRP without the Fed’s intervening again. Before quantitative easing (QE), the Fed’s balance sheet was $1 trillion. It grew to $9 trillion and is gradually being unwound currently.
A much bigger problem
The official US debt is $35 trillion, but the “Off Balance Sheet Debt” for Social Security, Medicare and other unfunded liabilities is an additional $216 trillion—6 times the official number. As shown in the following, we each owe $642,073.
Baby Boomer warning
Baby Boomers are in jeopardy of losing their lifetime savings or finding that these savings buy much less. They will spend this decade in the “Retirement Risk Zone” when investment losses can ruin the rest of their life. Their loss will also be their heirs’ loss. They need to move to the safety of short term TIPS and other inflation-protected investments like real assets, until they are beyond the Risk Zone (in the 2030s).
Importantly, they are not protected in most target date funds, so they need to know their risk exposure, and move out if they are not protected.
Conclusion
It’s complicated. Being the largest economy in the world adds to the complexity. When the US sneezes, the world catches a cold. Ignoring the problem will not work.
Can a debt spiral be avoided? Let’s hope. It won’t be easy.
SEE ALSO:
• DOL Final Fiduciary Rules Could Resolve Conflicting Interests in Target Date Funds
• There’s No Way Out. Deal With It.