This summer, amidst celebrations for America's 250th birthday, Taylor Swift's wedding, and the football World Cup, concerns about the nation's economy have emerged significantly.
This week, the troubling news that the US national debt has surpassed the $40 trillion (£29.4 trillion) mark has made headlines, raising alarms both domestically and internationally.
So how did we find ourselves in this situation? According to Maya MacGuineas, president of the Committee for a Responsible Federal Budget, it took nearly two centuries for the national debt to hit $1 trillion for the first time in 1981. That milestone was viewed as a crucial warning. "At that time, President [Ronald] Reagan told the nation in a televised address, 'If we as a nation needed a warning, let that be it,'" she noted.
Fast forward to our current 250th year, and the nation is spending more on interest payments on the debt than the entire debt from back then.
While reaching the $40 trillion milestone was somewhat anticipated, mainly due to escalated public spending under both the Trump and Biden administrations, it symbolizes a critical turning point. Increasing costs for social programs and various expenditures have surpassed revenues, which have been weakened by tax cuts. Additionally, responses to significant crises like the 2008 financial meltdown and the COVID pandemic have led to soaring borrowing levels.
Add to that the rising interest rates responding to recent inflation shocks, and the outlook begins to appear discouraging.
So, how serious is the situation? At the start of Trump’s first presidential term in 2016, the national debt of the US was just shy of $20 trillion. In the decade since, that figure has doubled.
Currently, it's increasing at a staggering rate of around $90,000 every second, or $7.8 billion per day, as noted by the Congressional Joint Economic Committee.
According to Eric Swanson, an economics professor at the University of California and a former senior economist at the Federal Reserve, the current climate is markedly different from a decade ago, particularly concerning interest rates.
“Long-term interest rates in the US are at multi-decade highs. This spike is partly due to inflation concerns, but it also stems from the astonishing levels of US government borrowing.”
The bond market is reacting by demanding higher returns, as investors grow cautious about the enormity of US debt. Furthermore, tech companies, which are borrowing vast amounts for AI investments, are also vying for the same pool of investors’ funds.
“When interest rates rise, financing the deficit becomes more costly,” states economist Mohamed A El-Erian, who teaches at the Wharton School.
Interest payments on government debt have surged 15% compared to the same period last year, according to El-Erian. These payments now account for nearly 20% of tax revenue, which he notes is "larger than defense."
Should we be concerned? The US is approaching its debt ceiling of $41.1 trillion, with projections from the Congressional Budget Office indicating that the debt could balloon to around $64 trillion by 2036.
However, economists believe the situation is not yet dire. El-Erian explains that the US, as the world's largest economy and with the dollar serving as the global reserve currency, has a "much longer runway to fiscally misbehave" than many other nations.
"We're nearing a point where the warning light is flashing yellow. It's not a flashing red light yet," he comments.
According to Swanson, other countries have faced similar or even higher levels of debt.
While the US national debt stands at 126% of the economy's size, it remains lower than that of other G7 nations like Japan and Italy.
Investor interest in lending money to the US government through bond purchases is reportedly "diminishing," according to Swanson. This shift is creating a "vicious" cycle where the government is compelled to offer increasingly higher returns to entice investors to buy its debt.
As borrowing costs in the US rise, other countries may also experience increased borrowing expenses. "What happens in the US never stays in the US," warns El-Erian.
Charlie Bean, an emeritus economics professor at the London School of Economics, cautions that if the US debt-to-economy ratio surpasses a specific threshold, it could trigger a fire sale of US bonds and potentially lead to turmoil in financial markets.
"There likely is a tipping point, but unfortunately, it’s not clearly defined," he explains. "There isn't a predetermined figure; for instance, reaching 150 percent isn’t a guaranteed catastrophe, while staying at 145 percent might seem safe."
Implications for Consumers
As a result of the current financial landscape, households are expected to encounter increased rates on mortgages, auto loans, and credit cards. This situation is likely to impact lower-income individuals the most, according to El-Erian.
Higher borrowing costs faced by companies can lead to increased prices for consumers, as these additional costs are often passed down. According to MacGuineas, the effects of debt can directly impact people's finances in various ways.
Looking ahead, the latest data from the US indicates that while the economy has slowed recently, it is still experiencing reasonable growth. This is significant because economic growth translates to increased tax revenue, which can be used to fund government initiatives and manage interest payments. El-Erian notes that consistent growth can help alleviate the debt situation.
However, if growth remains inadequate, the US may need to consider alternative measures. Potential options include reforming the tax system and public spending or implementing austerity measures. Debt restructuring could also be on the table.
Recently, the Treasury Department has engaged in financial engineering by purchasing government debt to stimulate demand for bonds and reduce borrowing rates. However, this effect was temporary, as long-term borrowing costs rose again shortly thereafter.
As the mid-term elections draw near, the White House is keen to project progress on economic issues, particularly as affordability emerges as voters' primary concern. However, alternative strategies appear to be lacking, and economist Mohamed El-Erian expresses skepticism regarding the government’s willingness to explore other options.
“I don't foresee any significant measures that will materially reduce the deficit in the next two to three years. The political discourse currently centers on tax cuts,” El-Erian stated.
