US Debt Level has Major Implications for Economic Growth & Market Valuations

The trajectory of U.S. debt has been a subject of increasing concern as it has ballooned from a modest $70 million in 1790 to an overwhelming $35 trillion today, which is a staggering 500,000% increase. This dramatic escalation not only highlights the fiscal policy shifts over the past few centuries, but also poses pressing questions about the future sustainability of such US debt levels and its implications for economic growth and market stability.

The Surge in US Debt Level: A Historical Perspective

In the early stages of the United States’ fiscal history, the accumulation of national debt was a slow and steady process. The country’s debt, which began at a modest $70 million in 1790, took more than two centuries to reach the substantial $1 trillion mark in 1980. This gradual rise reflected the nation’s cautious approach to borrowing and spending during this period.

However, this approach drastically changed in the subsequent decades. The rate at which the US debt has piled up since 1980 has been nothing short of staggering. Within a mere 40-year span, the US debt has skyrocketed to an astounding $35 trillion. This exponential growth in debt represents a significant shift in the nation’s financial practices. In just the last year alone, the US debt has surged by an unprecedented $3 trillion.

Economic Growth Versus Rising US Debt Level

The increasing national debt has been accompanied by economic growth that is not able to keep up, particularly noticeable since the debt level exceeded the GDP in 2015. Today, the U.S. debt stands at approximately 120% of the GDP, a figure that is not only the highest since 1966, but also signals potential economic headwinds. The government’s own forecasts predicts further significant increases in US debt levels, suggesting that without significant policy changes, the fiscal health of the nation could be at serious risk.

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Market Dynamics: Disregarding the US Debt Level?

Despite the ominous debt figures, the stock market has shown remarkable resilience and even growth. This apparent disconnect raises questions about the market’s sensitivity to macroeconomic indicators such as the debt-to-GDP ratio. Over the last 50 years, particularly between 2010 and today, the market has performed exceptionally well, despite the growing national debt. This scenario shows that market dynamics may be influenced by factors other than just economic indicators, such as investor sentiment, global economic conditions, and monetary policy.

The Academic View: US Debt Level’s Impact on Growth

Numerous studies have consistently shown that higher levels of debt correlate with slower economic growth. When the Debt-to-GDP ratio remains below 30%, economies can achieve growth rates around 4%. However, as debt levels rise above 90%, growth rates typically fall below 2%. Currently, the U.S. is experiencing this latter scenario, which is associated with sluggish economic performance. This slowdown is evident when comparing the robust growth rates of the post-war era to the relatively modest 2% growth rates seen today.

Long-Term Economic Trends

The long-term economic growth of the United States has been declining since the 1970s, a trend that coincides with rising debt levels. This period has seen a shift from a high-growth economy to one characterized by slower growth and increased fiscal burdens. The cause and effect relationship between a slowing economy and rising debt levels is complex and likely bi-directional, but the correlation between these factors is clear and concerning.

Interest Rates and Market Valuations

The relationship between interest rates and stock market valuations has been inverse over the decades. Historically low interest rates have been a major driver of the stock market’s high valuations. Conversely, any significant rise in interest rates could trigger a market correction. Higher debt often leads to higher interest rates as investors demand more return for increased risk. A 1% rise in the debt-to-GDP ratio typically increase rates by 0.04%, based on academic research

Projections show a possible 50% increase in debt-to-GDP over the next 10-15 years, which could result in a 2% rise in long-term interest rates. If this happens, possibly due to a risk premium associated with higher debt levels, the stock market could face a drastic downturn, especially from a valuation standpoint. The potential for interest rates to reach 7% in the next decade could severely impact market valuations, prompting a significant market correction.

Recent Trends and Forecasts

Fluctuations in oil prices have often preceded changes in interest rates, providing to be a predictive signal for yields. Recently, we’ve seen oil prices reverse and that might be foreshadowing a decline in interest rates, just like it did back in October 2023. In our opinion, this is a bullish development for the stock market.

Conclusion

The escalating US debt presents a formidable challenge, not just in terms of fiscal sustainability but also in its potential to stunt economic growth and destabilize financial markets. While the stock market has historically seemed indifferent to rising debt levels, the looming possibility of increasing interest rates could significantly alter this landscape. In the near-term, however, a reversal in oil prices point towards falling yields, which should be a bullish development for the stock market that is still maintaining its bullish posturing. Click here to get a 7-day free trial! Subscribe to our YouTube channel and Follow us on Twitter for more updates!