The US Government Debt Bubble is Bursting Before Our Eyes

If current trends continue, the US government is on a path toward a destructive debt spiral with severe repercussions for the financial sector, pension funds, banks, and the global economy.

The US debt bubble is on the verge of bursting, primarily indicated by the explosive growth in government interest payments, as shown in the accompanying graph.

Currently, the US government is increasing its debt by approximately a trillion dollars every 100 days

If this pace continues, the debt will grow by $3.6 trillion in a year. For context, in 2020, during the height of the COVID-19 crisis when economies were nearly shut down, the US debt increased by about $4.5 trillion. This fiscal year, the US government’s revenue (primarily from taxes) is projected to be $4.9 trillion.

To finance its debt, the US government issues bonds that require buyers. As the supply of bonds increases, demand must also rise. The current pace of supply growth makes it difficult to envision who will continue to purchase these bonds, especially since China and several other key countries are selling US Treasuries instead.

If demand falls short, the government will be forced to issue bonds with higher interest rates, which are essentially set by the market. While higher rates may attract more buyers, the sustainability of this strategy is questionable. What will the interest rates be in the coming years, given the deep budget deficits and a debt burden that continues to outpace the economy?

In recent years, we have witnessed a sharp increase in interest rates, leading to an explosive growth in interest payments. This trend threatens to push the US into a debt spiral, where rising interest rates make debt servicing increasingly difficult. If the debt cannot be serviced, investors will demand even higher rates, exacerbating the problem. This is the essence of the debt spiral.

The US Treasury Market Affects The Entire World

For the past half-century, the US Treasury bond market has been the largest and most liquid market in the world. A decline in this market significantly impacts the global economy, as US bonds are held in substantial amounts by governments, investment and pension funds, and commercial banks. When bond prices fall, their yields (or interest rates) rise.

This turmoil in the US bond market is one of the reasons why the prices of bitcoin and gold have surged this year. Gold recently surpassed the $2,400 mark, setting record highs across all major currencies.

Since the beginning of the year, gold’s price has increased by about 15%

Meanwhile, Bitcoin has roughly halved in price since the start of the year.

In the first half of fiscal year 2024, the US government budget deficit reached $1.1 trillion. This growing deficit is driven by swelling interest payments and increased defense spending. Additionally, declining tax receipts have pressured the budget; for instance, in fiscal year 2023, tax receipts fell by 9% compared to the previous year.

An Explosive Growth in Interest Payments

Annualised interest payments on the U.S. national debt surged to $1.06 trillion in the first quarter of this year

Over the past three years, these payments have doubled. By comparison, it took 16 years (from 2003 to 2019) for interest payments to double previously, and before that, it took 19 years (from 1988 to 2003).

Additionally, interest payments have now surpassed US defense spending, which is projected to reach $842 billion in fiscal year 2024.

The US national debt has increased rapidly this century, prompting long-standing concerns about the unsustainability of such high levels of debt. Unlike the debt crises experienced in Europe during the 2010s, the US has not faced a similar crisis.

A key reason for this is the long-term downward cycle in interest rates from 1980 to 2020. During this period, new state debt was issued at progressively lower interest rates, and previous loans were refinanced with cheaper ones. Consequently, the debt burden continued to grow.

This reliance on falling interest rates created a debt bubble dependent on cheap money. Interest rates declined for 40 consecutive years, but this trend has now reversed.

The Decades-Long Cycle Has Reversed

Interest rates have remained within a relatively narrow range for decades. It shows the yield (interest rate) of US 10-year government bonds, which is considered the benchmark for the entire bond market. The interest rates of many other debt instruments are influenced by this key metric.

Despite the growing debt burden, lower and lower interest rates were paid on the national debt. This was largely due to the Federal Reserve, which controls base interest rates, lowering them during each economic crisis to prevent deeper recessions.

However, these measures often postponed rather than resolved the root causes of the crises. While the previous century relied on sharply lowering interest rates, this century has seen the addition of extensive money printing.

To artificially stabilise the economy during crises, increasingly larger amounts of money were injected, as witnessed during the 2008 and 2020 crises

The consistent drop in interest rates and the Federal Reserve’s market interventions have made interest payments increasingly smaller relative to the overall debt burden and the economy.

The independent Congressional Budget Office (CBO) projects that this figure will rise to 3.1 percent this year and to 3.9 percent by 2034. However, this is a very conservative forecast, assuming that the Federal Reserve’s benchmark interest rate will average 3 percent over the next 10 years, compared to the current rate of 5.5 percent.

Interest Can’t Be Kept Down for Long

However, in some essence, the Federal Reserve will not be able to lower interest rates for an extended period. It is highly likely that high inflation will persist, and we may even see a second or third wave of inflation. Several key underlying trends support this view, including the commodity supercycle, record debt burdens, de-globalisation, demographic shifts, and global labor shortages in the fixed term.

Although 3.9 percent is the highest rate in the last hundred years, it could rise significantly, potentially reaching 5-10 percent within the next decade, especially given the rapid increase in recent years.

If this happens, the US would spend 5-10 percent of its gross economic product solely on servicing the interest on the national debt. In such a scenario, the government would allocate about half of its tax revenue to interest payments alone.

It is hard to imagine that, under such circumstances, the economy and financial markets could continue operating as usual. This scenario would likely lead to a global inflationary debt crisis, potentially culminating in the collapse of the dollar-based global monetary system.

The Volumes of National Debt are at Record Levels Compared to the Economy

Returning to the US national debt, the graph below illustrates its size relative to the gross domestic product (GDP). Since the 1980s, the national debt has grown rapidly and now exceeds even the levels seen during World War II. This is clearly an unsustainable situation, and reducing this debt will be an extremely challenging task.

In the aftermath of World War II, the United States was in a more favourable position. It accounted for half of the global economy, benefited greatly from the new Bretton Woods monetary system. It was home to much of the world’s industrial production, which played a crucial role in rebuilding the war-torn global economy.

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In the early 1980s, the interest paid on the US national debt exceeded 10 percent, but the debt was manageable because it was relatively small compared to the economy (about 30-35 percent of GDP). Today, the debt exceeds 120 percent of GDP, and interest rates above 10 percent would be catastrophic for both the dollar and the debt-based monetary system. As mentioned earlier, such a significant rise in interest rates is not out of the question in an inflationary environment.

The Federal Reserve might intervene by purchasing bonds from the market to support the bond market and the US government. However, this would necessitate money printing, which in turn fuels inflation. If bond interest rates continue to rise, it is likely that more money will be printed, but interest rates will also be raised to combat inflation.

This scenario would be akin to trying to extinguish a fire (inflation) with water (raising interest rates) while simultaneously adding fuel (printing money). Such actions would result in a significant transfer of wealth from corporations and individuals to the US government and the financial sector, primarily benefiting banks.

Debts Keep Increasing, But Buyers’ Interest is Waning

Examining the withdrawal of foreign investors (countries, funds, etc.) from US debt, the continuous issuance of new debt by the US, and the rising interest rates, it is evident that interest payments will continue to expand.

The chart below highlights the holders of US Treasuries. It clearly shows a decline in foreign investors’ interest in US debt. In October, the volume of US Treasuries held by China dropped to its lowest level since 2009.

The Government Pays Higher and Higher Interest on the Debt

Additionally, the interest rate that the US government pays on its total debt is rising. Currently, it stands at 2.9 percent, but since market interest rates are higher, the government must refinance the debt at increasingly higher rates.

As a result, the rise in market interest rates does not immediately affect the government’s interest payments. For instance, if the US government issued a 10-year loan in 2020 at 0.5 percent, the interest on this loan remains fixed until its maturity in 2030, regardless of how the market rates for 10-year bonds fluctuate.

In addition to 10-year bonds, the US government issues bonds with varying maturities, ranging from 3 months to 30 years. As of last year, the average maturity of the entire national debt was 75 months, or approximately 6.3 years.

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Eighteen percent of this debt consists of short-term Treasury bills, which have maturities of 12 months or less. This means that at least 18 percent of the debt must be refinanced (repaid with new loans) within the next year. Medium-term bonds, or Treasury notes, have maturities ranging from 2 to 10 years, while long-term bonds, or Treasury bonds, have maturities of 20 or 30 years.

The chart below displays the interest rates for bonds with varying maturities. Notice that short-term interest rates are higher than long-term rates, a phenomenon known as an inversion of the yield curve. You can learn more about the significance of yield curve inversion and its reputation as the most reliable predictor of recessions here.

If we continue on this path, the US government and the Federal Reserve will soon face a significant challenge: maintaining the stability of a debt bubble that has been inflating for 40 years and is now on the verge of bursting. Any economic or financial crisis will exacerbate this issue, necessitating even more money printing and borrowing to manage the next crisis.

The debt crisis has already begun, with its consequences still unfolding and evolving. This process can last for years, but typically accelerates over time, leading to a decline in the purchasing power of currencies and a substantial transfer of wealth. The cost of living in the US may also be exacerbated by this.