Unsustainable US debt & Consequences

U.S. debt situation looks 'unsustainable', IMF warns

The US debt situation is looking increasingly precarious, and corporate defaults are up as interest rates stay high, according to the International Monetary Fund.

The US's fiscal situation is the "most worrying" among all world countries, the IMF's research director Pierre-Olivier Gourinchas said. That's largely due to the rapid pace of government spending, with the US already having racked up a $1.5 trillion deficit in the first 11 months of the fiscal year. "Under unchanged policies, debt dynamics in the US are very unfavorable," he said, later adding that the "the perpetuation of current policies entails an unsustainable fiscal path.” The surge in debt has coincided with an explosion in the federal deficit to $1.7 trillion in 2023.

US Government Debt

US government debt is on track to surpass $50 trillion by 2033, Bank of America?said citing data from the Congressional Budget Office

The?public debt of the United States?has increased significantly over the past 30 years, as it was around 3.2 trillion U.S. dollars in 1990.

The problem of the federal debt

US public debt outstanding currently sits at $33.6 trillion (121% of 2022's GDP) and is expected to surge by $20 trillion to $54 trillion within the next decade amid "fiscal excess in the 2020s,"

"US public debt is... more than the combined GDPs of China, Japan, Germany, and India.

When?broken down per capita, the national debt amounted to about 80,885 U.S. dollars of debt per person in the United States in 2021.

Sovereign credit ratings:

A study conducted by the World Bank has found that nations whose debt to GDP ratios stay more than?77%?for extended periods encounter substantial slowdowns in economic growth and, each additional percentage point of debt above this threshold level costs the country 0.017 percentage points in economic growth. Debt-to-GDP ratio and sovereign credit ratings are complementary indicators that provide insights into different aspects of a country's financial health. Fitch & S & P has assigned sovereign ratings of AA+ to USA. For India, they have given ratings of BBB-. That shows lack of objectivity on the part of rating agencies.

U.S. has had a debt-to-GDP of over 77% until recently, currently at 121%. India's debt to GDP ratio has remained stable at around 70%.

Why such high Debt to GDP of USA is not sustainable?

US is neither at war nor in a recession but it is running a budget deficit of 7 % of GDP with deficits projected to reach 10 % of GDP by 2030 and to increase from there as Medicare and social security programs put a greater burden on the nation’s finances. If more spending on defense and decarburization is needed, then the outlook will grow even grimmer.

A country’s natural debt limit depends on many factors, including savings rates, productivity growth and demographics. For Japan, the limit is very high because its household savings rate is so elevated.

Within 10/20 years the US federal debt will have climbed from its current level of 121 % of GDP to 200 %. The debt burden will then have become unsustainable, with no way of avoiding an actual default or, alternatively, an implicit default in the form of a very long period of debilitating high inflation that reduces the debt in real terms. The holders of long-term government bonds now face a simple choice. If they believe the US has the political will to make the hard choices on taxes and spending that will avert a crisis, then hold on to their bonds. If not, then sell the bonds today.

Joe Biden and Donald Trump are big spenders who have little concern for burgeoning federal government debt.

The dramatic rise in yields is not entirely due to fears about burgeoning deficits and debt. Natural buyers of US treasury bonds, including central banks and commercial banks, have withdrawn from the market for a variety of reasons. Nonetheless, concerns that the US federal government will not mend its tax and spending ways without a major crisis will continue to grow among investors. Yields will continue to rise until the problem is addressed. The effects of those rising treasury yields will be felt across the US capital markets and its real economy. Investors in long-duration investments of every kind – stocks, commercial property, corporate bonds, infrastructure and more – will demand higher returns, which will send prices down considerably.

Damage to the real economy will be equally large. The US residential property market has already frozen as 30-year mortgage fixed rates have risen from 3.5 % to 7.5 % in 18 months. The US banking system will again be destabilized by even greater losses on banks’ bond holdings.

"Making debt more expensive is an intended consequence of tightening monetary policy to contain inflation. The risk, however, is that borrowers might already be in precarious positions financially, and the higher interest rates could amplify these fragilities, leading to a surge of defaults," the IMF warned.

The surge in annual interest payments caused by spiking bond yields are taking up a bigger slice of the federal budget and widening deficits.

It’s likely that Fed may simply bail out government in coming years via quantitative easing and the introduction of yield curve control (policies that would be US dollar negative).

A separate measure of US debt that's more closely followed by economists is "debt held by the public," which is less daunting but still on a steep uptrend. At the end of fiscal 2023, it stood at $26.3 trillion, or 98% of projected GDP, and the CBO sees it climbing to 115% by 2033.

Debt Limit politics In USA, over the past decade, the?federal debt limit in USA?has increased significantly. The U.S. debt ceiling can only be changed by an act of Congress which is then signed by the president. The raising of the ceiling has become a recurring political issue in recent years, especially during times when the Presidency and chambers of Congress are controlled by different parties. ?Global bond market is watching the?turmoil in the US Congress very closely.?More and more bond market investors are concluding that US politics-as-usual is incapable of defusing America’s ticking debt bomb. Only a major bond market crisis will shock the US polity into making the tough decisions needed to right America’s fiscal ship. There is a limit to how much debt any government can accumulate?before a debt spiral begins?in which debt holders’ fear of default causes them to demand higher interest rates, which then causes higher deficits and more debt and then even-higher interest rates, deficits and debt in turn.

Can corporate America cope with its vast debt pile?

Rapid increases in borrowing costs prompt concerns about more defaults on $13tn of debt, but companies are finding new ways to survive

Such activity is a sign that a new era of high borrowing costs is starting to bite in corporate America, whose overall borrowings now total $13tn according to Federal Reserve data.

And, the already large problem of refinancing the debt of companies, commercial property investors and private equity firms, that was originally made when interest rates were far lower, will be made worse. Many things will break. Higher rates are also bound to spark some distress for borrowers, with over $2 trillion of corporate debt set to mature in the US alone in 2024.

Businesses that grew accustomed to cheap debt during more than a decade of ultra-low interest rates must now adjust to a world where financing costs more. ?Since March 2022 the Federal Reserve has raised interest rates from near-zero to a range of 5.25 to 5.5 %.

If that is the case, then more companies are going to need to either repay their loans, or refinance them at substantially higher cost. Over $3tn of corporate debt is due for repayment over the coming five years. “So many companies have really benefited greatly from the zero cost of capital,” “You’ll be in this persistently higher-than-normal distressed default environment as a consequence.”

Eroding buffers

In the corporate world, many businesses suffered closures during the pandemic, and others emerged with healthy cash buffers thanks in part to fiscal support in many countries. Firms were also able to protect their profit margins even though inflation had picked up. In a higher-for-longer world, however, many firms are drawing down cash buffers as earnings moderate and as debt servicing costs rise.

The GFSR shows increasing shares of small and mid-sized firms in both advanced and emerging market economies with barely enough cash to pay their interest expenses. And defaults are on the rise in the leveraged loan market, where financially weaker firms borrow. These troubles are likely going to worsen in the coming year as more than $5.5 trillion of corporate debt comes due.

CA Harshad Shah, Mumbai, [email protected]