The US Literally Cannot Repay Its National Debt
US National debt is expected to surpass its historical peak of 106% of GDP. It is rising from 99% this year to 122% in 2034. This increase will also raise the US debt GDP ratio. This situation sets America in a difficult position. While boosting taxes is also controversial right now, cutting back in other areas is unlikely to get public acceptance. To exacerbate problems, the US has not seen in more over two decades another difficulty: increased interest rates.
The Federal Reserve in the United States is the central bank that sets interest rates; so, they have responsibility. The Federal Reserve operates independently under contract with the US government. It mostly controls interest rates to preserve economic stability and value of the US dollar. But the current inflation rise has caused the Federal Reserve to hike interest rates from zero to roughly 5.5%.
The maturity date of government debt helps to explain the notable increase in interest rates. The US owes the bondholders when government debts mature. The US deficit means the country runs without the required money for repayment. It turns to rolling over the debt. The US does this by building fresh bonds to pay off the existing ones. The difficulty stems from the current environment. The refinancing now calls for higher rates. The earlier debt was obtained at reduced interest rates. As extra debts are rolled over, the annual interest payments rise and worsen the deficit.
For the US, interest payments now rank third among all the expenses in the current fiscal year. The US has spent $ 601 billion only on interest payments since October 2023. The assessment of the Congressional Budget Office indicates that these expenses are expected to explode in the next years. Interest expenses are expected to exceed any point since 1940 by 2025, rising to 4.1% of GDP by 2034 — or one-sixth of total federal expenditure. Mandatory spending on the increase means that government discretionary expenditure is anticipated to drop drastically. To pay the growing interest, this situation calls for more strict policies including more taxes or more borrowing.
In such cases, the idea of a debt spiral is relevant. Rising interest rates result in larger interest payments on rolled over government debt. The government then borrows more money to fulfill these responsibilities. This borrowing leads to an always growing debt load with high interest rates. The US seems to have difficult work ahead of it. The optimal answer is to aim towards lowering the deficit. The goal is to finally reach a surplus. As such, some people have considered inflating away the debt as a different strategy.
The plan of inflating away the debt is based on using inflation to reduce the value of the currency. This approach allows the government to pay fixed-rate debt with depreciated money in the future. This strategy is like the strategy the US used following World War II. Back then, the debt to GDP ratio was significantly lowered with the help of inflation. The modern implementation of this approach is the Federal Reserve enacting quantitative easing. The central bank creates money to buy government bonds. The flood of extra US dollars into the system provides the government with money for spending. Ideally, it would be spent on projects increasing the national output.
Although theoretically inflating away the debt looks good, its actual implementation is somewhat difficult. The main issue is the possible effects of raising inflation, which, if unchecked might spiral out of control. Unchecked inflation has been shown historically to cause social discontent. It also results in economic instability and the abandonment or collapse of a currency. Unsustainable recent inflation rates in the US and other Western countries have driven the Federal Reserve to step in. They increased interest rates to lower inflation.
Maintaining a 2% inflation rate by the Federal Reserve is meant to promote slow economic development. It also aims for price stability across time. This deliberate approach helps the economy to progress. It also enables consistent salary increases, boosts investment, and gradually depreciates the currency. Hence, debt is reduced over time. Although the cooperation between the government and the central bank provides a route to reduce the debt load, the plan has to be constantly watched over. The plan also has to be changed to balance possible negative effects.
In essence, even if using inflation to help to lower the debt load is a good approach, the US should give top priority to putting good fiscal policies into effect. The US should also give top priority to deficit reduction. Managing the debt of the nation most sustainably is by achieving a surplus. One can find a clear example from Australia, where careful financial management resulted in a surplus even with debt responsibilities. America may negotiate its debt problems and open the path for strong financial stability by matching with ideas of productivity improvement and sensible spending.
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Posted on national debt, US economy
Originally published at http://munaeem.de on September 8, 2024.
