There is a concept in aerial navigation called “the point of no return.” As the phrase implies, the point of no return is the distance beyond which a flight’s return to the point of departure is no longer possible due to dwindling fuel supplies. More generally, the phrase implies that turning back is no longer an option.
We have passed the point of no return with regard to our national debt. From here, we enter a dangerous and spiraling vortex.
The US government is running a multi-trillion deficit, which can only be funded by additional debt. This was manageable so long as interest rates remained near zero. But now interest rates are pushing above five percent. As a consequence, debt service costs are growing faster than they can be paid for, and they can only be funded by running deficits and piling on yet more debt in a vain attempt to cover them.
When a government takes out a bond to build a road, bridge or highway, the toll, as well as the future productivity of that infrastructure, enables economic growth and thus the revenues to repay it. But that is not what his happening here. The deficit represents unproductive and massive social entitlements as well as destructive armaments spending being squandered on endless wars in Ukraine and elsewhere. Neither of these will have a positive return on investment.
The US government now must raise nearly $2 trillion in debt financing from the bond markets by the end of 2023. The US Treasury has been forced to offer record yields in recent public auctions to induce bond investors to bite. Even still, the market for Treasuries is showing signs of indigestion. The fact that the US has no hope of ever repaying the debt, other than with more debt, is finally catching the attention of the markets. This is a problem for the US government and for the US economy.
The recent downgrade by Fitch (a credit ratings agency) of the United States’ sovereign debt rating, from AAA to AA+, underscored the point. With Federal obligations of nearly $33 trillion, and interest rates now expected to be “higher for longer,” the cost of servicing the interest on the national debt will add well over one trillion dollars per year to the deficit, and ultimately to the debt balance. Vicious cycle ensues.
It would be one thing if there were sufficient tax revenues to service the debt. But the economy is not growing quickly enough, and tax receipts are down year over year. There is no prospect whatsoever that this debt can be paid off.
As US debt becomes a less attractive option to investors, the Federal Reserve will be forced monetize the debt, i.e., to act as the buyer of last resort of US Treasury securities. This it did in 2020-2021, when the Fed doubled the size of its balance sheet to nearly $9 trillion. A new round of monetization will lead to an increase in the money supply, which in turn will increase the inflationary pressures already bubbling in the economy. Already, CPI has reverted upwards, with July’s headline figure coming in at 3.2 percent, while CPI excluding food and energy was substantially worse at 4.7 percent.
At some point—perhaps with the next, more serious leg of the banking crisis, or perhaps when the US government starts to wobble under the payments strain—the Federal Reserve will have to substantially ease up on interest rates, which will remove whatever restraints rising interest rates have served to moderate inflation. At that point, rapidly growing debt alongside lower interest rates will lead to an inflationary spiral.
The US Congress had opportunity to address this crisis when the debt ceiling was being negotiated in May. Unable to reach agreement, the parties kicked the can down the road until 2025. By then national debt will have increased by several trillion more, and inflation will have gained the upper hand. Any solution will by then require more pain, not less.
I wrote in The Epoch Times last month that the debt-related alarm bells were being ignored. With the subsequent Fitch downgrade and new information about how much additional debt will be required, the markets are starting to wake up to the dangers. This newfound awareness by creditors and counterparties will only make the Fed’s and US Treasury’s position more untenable.
This spiraling process: runaway deficits leading to more debt leading to higher inflation from monetary expansion, is a doom loop. Now that we’ve entered it, how do we get out? Only by the severest of measures to cut deficit spending, which is an option that neither party will have the courage to take. The US can’t default, nor can it tax the problem away. That leaves inflation as the only remaining path. So instead of price stability, we can expect to see inflation return with a vengeance as the Fed is forced to reverse course on interest rates.
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