I sent the following article from the WSJ to Scott:
The Silent Price You’ll Pay for Our Mounting National Debt
The cost of borrowing is near untenable levels. If we aren’t already in a ‘doom loop,’ we’re getting close.
By Red Jahncke
Sept. 29, 2022 6:05 pm ET
After an unexpectedly hawkish Federal Reserve raised interest rates by 75 basis points for the third consecutive time last week, all eyes were on markets and the economy. Few, however, paid attention to the effect persistent inflation and higher interest rates will have on Uncle Sam.
That’s surprising. The gross interest expense on the national debt hit $88 billion in August, according to the Monthly Treasury Statement. That’s $1.06 trillion a year. Interest on the national debt is exploding and heading toward what economists refer to as a “doom loop”—the vicious circle in which the government’s borrowing to pay interest generates yet more interest and yet more borrowing.
Net interest expense (gross expense minus the interest received) hit $63 billion in August, or $756 billion a year. That’s a lot of money in the context of a $6 trillion federal budget and a $25 trillion economy.
The August numbers barely reflect the impact of the Fed’s interest-rate hikes between March and July, much less last Wednesday’s increase and the additional 1.25% by year’s end implied by the Fed’s new guidance. It’s highly likely that gross interest expense will rise well above $1 trillion a year and surpass Social Security as the largest item in the federal budget.
The Fed’s more hawkish guidance calls for “higher rates for longer,” even if it brings on recession. The central bank is also shrinking its holdings of Treasurys under its quantitative-tightening policy, requiring the Treasury Department to find alternative buyers. Weak demand will likely push rates higher, if not destabilize the Treasury market to some degree.
Yet even if the Fed backs off, or recession intervenes, that won’t relieve pressure on Uncle Sam. Treasury debt has reached record levels, and higher federal interest expense is already baked in. That will constrain Washington’s capacity to deliver fiscal stimulus to a struggling economy during the next recession. Constrained or not, the government will doubtless attempt to do so. That means issuing more debt, since the federal budget is in perpetual deficit.
That is exactly what has happened in the past 2½ years: Uncle Sam issued $7 trillion of new debt during the Covid pandemic, which took publicly held national debt to its present $24 trillion up from $17 trillion in February 2020.
The driving force behind the growth of our national debt alternates between surging interest costs attending a strong or inflationary economy and enormous additions to principal from deficit-financed stimulus during recession. In either case, the national debt is growing inexorably. How could financial markets ignore it?
One school of thought asserts that so long as the economy is growing at a faster rate than the debt, the increase in the national debt doesn’t matter.
But that certainly isn’t happening now. In principal amount, the national debt has exploded and the cost of debt service is escalating, too. The current $756 billion annual net interest expense on the $24 trillion of publicly held debt implies a required economic growth rate of more than 3% in a $25 trillion economy in order for the debt “not to matter.” The average forecast for economic growth in calendar year 2022 is less than 1%, and many economists expect negative growth—i.e., recession—in 2023.
Not only are rising interest rates driving up federal interest expense dramatically; inflation is propelling growth in government spending. Social Security benefits are adjusted based on the average of the consumer-price index reports for July, August and September each year. We have reports for two months and don’t need the third to know that benefits will increase next year to roughly $1.3 trillion from $1.2 trillion (or more than 8%).
Healthcare costs always exceed the rate of inflation, too. That guarantees double-digit growth next year in Medicare from about $710 billion in fiscal 2022 based on the first 11 months, and in the other government healthcare programs categorized as “health” in the Monthly Treasury Statement, which amounted to $915 billion in fiscal 2022. Assuming only 10% healthcare inflation, these two categories combined will grow by $163 billion.
Naturally, if we do slip—or plummet—into a serious recession, federal income-tax revenue will erode. Even before recession, the past nine months of declining stock and bond prices virtually assure an almost complete collapse in capital-gains-tax revenue come tax time next April. Loss of that category alone—which averages about 12% of federal individual income-tax revenue—will necessitate hundreds of billions in borrowing to replace lost revenue.
Inflation and interest rates are inflicting painful damage today. Yet seemingly without notice the national debt is working like a cancer sapping the nation’s long-term economic vitality. Whether we reach the “doom loop,” or just become mired in stagflation, unchecked government spending and mounting national debt will drain all growth potential from the national economy sooner rather than later.
Mr. Jahncke is president of the Connecticut-based Townsend Group International LLC
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My accompanying comments were as follows:
Scott:
Perhaps my memory plays tricks on me, but it seems like not so many years ago the interest on the debt was in the neighborhood of $250-300B and now this article from today's WSJ is talking about $756B-$1.06T and climbing!
(Simpleton that I am, I confess I am unclear on the logic of his distinguishing publicly and privately held debt i.e. why he is saying the debt is $24T and not the $30T I see elsewhere.)
Here are some simpleton ideas I am working with:
a) For napkin level calculations if we are staying with the $30T number and working with bonds being 3.5% and inflation being 13.5% (crudely compounding out the current monthly level of .1%) then the real burden of the $30T to the government is declining 10% a year. Does this make sense or am I making some sort of serious error in logic? This would seem to cut against the doom spiral this article is talking about? Or are things teetering on the edge of a spiral? And if so, what are the implications for a 70 year old man and his wife with what to do with their savings?
b) If I understand correctly, inflation is a monetary concept, but much of what we have now are price increases for many goods and services due to supply contraction. If my distinction is correct, then interest rates are the wrong tool. (If I have it right, I am following your analysis in this)
The Adventure continues,
Marc
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Here is his reply:
Debt held by the public is the only number that makes sense to use, and the latest figure is $24T. The $30T number is bogus, but that is the one you see most often.
Current cost of debt service is about $600-700 B, and that is only 2.4% of GDP, which is about as low as it’s ever been. The debt service burden (interest cost as a percent of GDP) is NOT currently a problem, not at all. But of course it is going to be rising now that interest rates are moving a lot higher. Still, it takes time for the recent rise to work its way through the Fed’s holdings, most of which still carry very low coupon yields.
CPI inflation is close to 10% but it has most likely peaked and is declining meaningfully (i.e. gasoline). PCE Core inflation—the Fed’s preferred measure—is only 5% and it is peaking but declining very slowly.
I think we’ll see gradual declines in YOY inflation for the next 6-9 months. The Fed has done what it needs to do. Most importantly, M2 is no longer increasing. No one is talking about that! That’s the elephant in the room.
Meanwhile, stocks have taken a huge hit. Now wouldn’t be a bad time to invest if you are sitting on a pile of cash.
If you are still risk averse and worried about everything going to hell in a handbasket, consider the TIP ETF. It has a real yield of about 1.7%, so your dividend is 1.7% plus whatever the CPI turns out to be. If the economy really crashes and the Fed overtightens, the real yields are going way down and the price of the fund will go up 10-20% on top of its dividend. So it’s a great hedge against bad stuff happening. Real yields can’t go much higher unless the economy takes off like a rocket, and that’s not happening under Biden.
Yes, there’s a certain amount of supply-constrained inflation in the CPI, and that is gradually going away. If M2 continues flat then overall inflation is going way down. The bond market agrees, with breakeven inflation now falling to a mere 2.1% over the next 5 years.
