09 Nov 2023
United States Declaration of Independence signatory Benjamin Franklin said: ‘I’d rather go to bed without dinner than to rise in debt’ and ‘If you know how to spend less than you get, you have the philosopher’s stone.’ The debt ceiling in the US was created under the Second Liberty Bond Act of 1917 and is defined as the total amount of money that the US government is authorised to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments.
Congress has authorised trillions of dollars in spending over the last decade, causing the US’ debt to nearly triple since 2009. The debt ceiling has been increased multiple times since 2013 to avoid the worst-case scenario, all without budgetary preconditions attached. The questions of whether to raise the ceiling or abolish it completely have become topics of heated debate among policymakers and have led to disruption and some actual government shutdowns. The debt ceiling was raised to $31.4 trillion by a congressional vote in December 2021, and signed into law by President Biden and in January of this year, the US has again exceeded its new debt ceiling of $31.4 trillion. So, what happens now?
After plentiful debate, lawmakers voted to suspend the ceiling until January 2025. The US is spending much more money than it receives in taxes and other revenue and to deal with the shortfall, the government borrows to finance the payments. As of November 2023, the total US national debt stood at a staggering $33.7 trillion. Let’s put this into perspective; there are 31,536,000 seconds in a year. If you spent $10 thousand every second from the end of the First World War to date, you still wouldn’t have spent $33.7 trillion.
How has it come to this? For years we’ve been in a low interest rate environment. In 2020, the US government borrowed to finance the pandemic, but the borrowing was secured over the short term and now that the debt needs to be refinanced in a higher rate environment, the debt just keeps on growing and this scenario will only intensify if, as predicted, rates stay higher for longer. It’s not just investors that have got used to low interest rates, it’s governments too and borrowing over the short term during the pandemic may be their downfall when it comes to trying to climb out of the debt ceiling crisis.
Thomas Jefferson, another Founding Father of the US said: ‘We must not let our rulers load us with perpetual debt’. When it comes to interest payments on debt, the harsh reality is that the numbers are increasing, reflecting the appreciation in bond yields since the Federal Reserve started its interest rate hiking cycle. In September 2020, the figure stood at $345 billion, in September 2021 interest payments had increased to $352 billion, in September 2022 there was a significant upward shift to $475 billion but September 2023 tops the charts at $660 billion. The interest payment figure is gaining serious momentum and is now so high that it could potentially exceed $1 trillion, which would overtake US defence spending.
What’s the impact of all this? Fitch has downgraded the US Long-Term Foreign Currency Issuer Default Rating from AAA to AA+ and has indicated that the downgrade reflects the expected fiscal deterioration over the next 3 years, a high ingrained general government debt burden and the erosion of governance. Investors have expressed concern surrounding the servicing of US debt at higher interest rates leading to concerns over supply versus demand. The biggest buyers of US Treasuries: China and Japan, have started to pull back, reflecting the changing investment landscape. In response to the increase in bond yields, the US government has been slowing the pace of longer dated bond issuances, but is this too little too late?
The International Monetary Fund is projecting that the US deficit will exceed 8% of GDP this year. The can has been kicked into 2025 when it comes to tackling the debt but when you start to look at these eye watering levels in the current economic backdrop, it’s hard to imagine how the US will ever get the situation under control.
What does the worst-case scenario look like? If the Treasury can't pay its expenses, there’s the risk that the US will default on its debt. If the government runs out of funds, the Treasury faces a stark choice: default on payments to bondholders or cease payment of funds owed to companies and individuals mandated but not fully funded by Congress. Both scenarios would likely result in a global economic meltdown and if the government was no longer able to issue new debt, it would have to balance the books by introducing budget cuts that would represent a sizeable proportion of the American economy.
So, the pressure is on for the US government to resolve their debt ceiling crisis, to get their budget deficits in order and to make sure that their interest payments don’t become the largest budget item spend. Issuing debt is all well and good but the level you service it at needs to be carefully managed and buyers need to be interested in what you’re selling. Herbert Hoover said: ‘Blessed are the young for they shall inherit the national debt’. It’s not just households that need to be fiscally responsible, it’s nations too, and the nation’s debt will become more and more of a burden to the individual if it isn’t brought under control.
Stuart Ryan, Head of Research
Katie Sykes, Client Engagement & Marketing Manager
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