Have you ever been in a hotel or office building where the fire alarm is blaring, but everyone ignores it and goes happily about their business? Every few minutes, a recorded voice chimes, “Fire! Please exit the building!” but the warning is disregarded. In fact, the longer the alarm sounds, the more people tend to discount it. With repetition, we become inured to the warnings. It is only when we smell the smoke and feel the heat of the flame do we realize the danger is imminently real. But of course, by then it is too late.
The United States is in an analogous position with regard to its own indebtedness. Observers have been warning for decades that runaway government deficit spending, funded not by revenues but by cheap debt, would eventually result in a collapse of the financial system, a severely damaged economy, and the abandonment of the U.S. dollar as the global reserve currency. These warnings have been infinitely repeated and repeatedly ignored. And now the flames are at the door.
On the eve of the global financial crisis, the Federal budget deficit, running by then for six years, stood at $1.7 trillion cumulatively since 2001. The national debt topped $9.3 trillion, equating to 63 percent of national income, as measured by Gross Domestic Product (GDP).
The statist interventions—facilitated by easy money policies—used by governments around the world to address the global financial crisis resulted in dramatically increased levels of sovereign debt in the U.S., Europe, and Japan. In the U.S., national debt doubled to over $18 trillion by 2015. The cumulative federal deficit grew to $8.8 trillion. Pundits warned that these debt levels, by then equating to 100 percent of U.S. GDP, was not sustainable, and that deficits of this magnitude would generate inflation.
But then nothing happened. Life went on. The equity markets produced one of the longest bull runs on record. Inflation was nowhere to be seen. The benefits of easy money were immediate, while the consequences lay somewhere in the distant future. In a world of “ZIRP,” the zero interest rate policy implemented and sustained by central banks for well over a decade following the crisis, a massive asset bubble was created, and with it the illusion of wealth. With low or even negative interest rates, western governments could afford to service their rapidly increasing levels of debt. With interest rates near zero, the natural constraint on deficit spending and debt accumulation was removed, and with it went all financial discipline, whether by households, corporations, or the government itself.
All this was happening while western governments were losing their democratic legitimacy, and with it, their leaders’ capacity to govern. In the U.S., a bitterly polarized Congress lost its ability to legislate. Eschewing sound fiscal policy and treating monetary policy as the magic wand, eyes turned to the Federal Reserve to keep interest rates low and to the U.S. Treasury to flood the markets with liquidity. This game is now up.
As a result of government actions to address the global financial crisis (i.e., by profligate money printing), reckless spending on endless wars in Afghanistan, Iraq, Syria, and now Ukraine, and pandemic relief “helicopter money” spending, by July 2023, the cumulative Federal budget deficit has ballooned to $20.7 trillion. As deficits (by definition) are not funded by revenues, the U.S. government borrowed from the public, from foreign governments, and eventually from itself. In just two years between 2020 and 2022, the balance sheet of the Federal Reserve more than doubled to nearly $9 billion, as the central bank was forced to acquire debt issued by the U.S. Treasury to fund pandemic handouts. This process began at the same moment that China, formerly the largest foreign holder of U.S. Treasury debt, was reducing its holdings in U.S. debt obligations and boosting its gold reserves instead.
At the end of the 2022, the national debt stood at $31.4 trillion. Just over six months later, another $1.3 trillion has been added, bringing the real-time total at the end of July 2023 to $32.7 trillion, or 136 percent of GDP. This translates to $97,500 in debt obligations per American citizen and $254,000 per taxpayer. Ready to pay up? But wait, that’s not all. Add to this another $4 trillion of state and local debt, equating to an additional $10,000 per citizen, and trillions of entitlement payments for social security, Medicare, and the like, and total government indebtedness is now at the point of no return, with no possibility of future repayment.
When interest rates were near zero, debt service costs could be ignored. But now, interest rates have risen rapidly. With the Fed Funds target rate now above five percent, the government’s debt service costs—now one of the largest line items in the Federal budget—is projected to be $724 billion, or 2.7 percent of GDP, for fiscal 2024. Debt service has become one of the largest budgetary items, rivaling military spending and entitlement programs.
Last week’s move by the Federal Reserve to raise its target interest rate an additional 25 basis points now puts the upper bound at 5.5 percent, the highest level in 20 years.
This is going to have adverse consequences for the banking sector, already fragile, and for both main street businesses and Wall Street financings. For the moment the market is ignoring the warnings. So too is the U.S. government ignoring the alarm bells. Eventually the crowd will notice that the fire is real. For now the music plays blithely on, and the dancers dance.
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