One trillion US dollars

The dust has settled on the US debt ceiling dispute. Investors have turned their attention elsewhere and appear to be oblivious to the fact that the issue will come up again in the next 18 to 24 months. Over the next few years, the US national debt will rise from over 32.5 trillion US dollars at present to around 40 trillion US dollars.

Despite the rising debt levels, the US Federal Reserve (Fed) raised interest rates by a further 25 basis points to 5.25% to 5.50%. The overall US yield curve (1 to 30 years) is between 3.95% (10 years) and 5.08% (1 year). We are therefore a long way from a low interest rate environment and refinancing the aforementioned 32.5 trillion US dollars is becoming increasingly expensive. Debt service has risen sharply over the past 12 to 18 months due to the higher interest rate environment. According to the St. Louis Fed, it has already reached 969 billion US dollars (Q2 2023) and is expected to exceed the mark of 1 trillion US dollars for the first time this quarter.

Absolute versus relative

At first glance, the absolute amount the US pays in interest each year is huge, especially when compared with something "tangible". The world's longest tunnel, Switzerland's 57-km-long Gotthard Base Tunnel, cost almost 15 billion US dollars to build. In comparison, the annual interest payments on US government debt are 65 times higher. But is the comparison with a railway tunnel in the Alps meaningful at all?

In my view, it would be unprofessional not to look at US interest payments in relative terms and compare them with something meaningful. Gross domestic product (GDP) is often used for a comparative analysis. If you put the value of the US interest payments in relation to US GDP, it amounts to less than 4% of the US economy. Historically, the figure was higher in the 1980s, at 5%.

Experience shows that it is more useful to compare interest rate payments with total government spending, i.e. to look at the share of debt service in total budget spending. Using the latest figures that number comes in at just 15%, but that is still more than 50% higher than before the pandemic. In the late 1980s and early 1990s, it peaked at 22%. In today's environment it is only a matter of time before these figures are reached again.

Medium- to long-term implications

The bottom line is that the US government is living beyond its means. I am sure that debt and interest payments will play a major role in the 2024 US election campaigns. The debate about the US dollar as the world's reserve currency does not make it any easier for the US to finance its deficits. It is possible that international investors in particular will expect higher yields on their exposure to US government bonds in the future. In an environment where the US dollar remains expensive in purchasing power terms and the US debt situation is unlikely to improve in the coming years, the greenback will tend to weaken over the medium to long term.