In the last two months, the market for U.S. debt has been relatively quiet, at least on the surface. That is about to change in the coming months—and change for the worse.
There are two reasons for this: the unending rise in the debt, and the rollover effect on existing debt. Over the next year, these two effects in combination could increase the cost of the federal government’s debt to the point where the interest on the debt rivals the total cost of Social Security.
Based on the current structure of the debt, the total interest payments on it for the 2024 fiscal year (ending on September 30th) are going to be $1.05-1.1 trillion. This is a conservative estimate, but if we extrapolate the current trend in the debt cost, by next summer it will reach $1.4 trillion.
That is what Social Security is estimated to cost in 2024. In other words, we can now begin to see the point on the horizon where the biggest expense for the U.S. government will be interest payments on its debt.
If not before, that point will most certainly trigger a fiscal crisis in America.
The main reason why this will happen is the rollover effect on the debt cost. It is rarely if ever discussed in the media, yet it is not very difficult to understand. Here is how it works:
- In January of Year 1, the Treasury sells $100 worth of debt securities. They mature in January of Year 2. Over their lifespan, these securities pay $2 in yield.
- In January of Year 2, the Treasury has to pay back the people who invested in the $100 of debt securities a year earlier. To do so, it sells a new batch of $100 debt and uses the revenue to pay back its former creditors. The yield is still $2 per year.
So far, the rollover of the $100 has had no effect on the debt cost. However, suppose this happens:
- In January of Year 3, the Treasury repeats the $100 debt sale, but now it has to pay $3 per year in interest.
This time, the rollover effect increases the debt cost by 50%.
Suppose, in addition, that the Treasury decided to expand its debt and sell an extra $50 of it in Year 3. Now the total debt cost is $4.50, compared to $3 if the debt had remained unchanged.
It is the combination of these two effects that the U.S. government is struggling with—and their problems are only getting worse. Here are some examples of how the rollover effect is hard at work increasing the debt cost.
In the auction for 5-year notes on May 28th, the U.S. Treasury sold $74.2 billion worth of debt at a median yield of 4.48%. This batch of debt replaced a maturing batch, i.e., the one that the Treasury sold five years ago, worth $45.3 billion. The average yield on that batch was 2.03%, which means that the Treasury paid $920 million per year to the holders of that debt.
By contrast, in the next five years, they are going to have to pay $3.3 billion per year to those who bought the $74.2 billion at the May 28th auction. This is an increase in the debt cost of almost 259%; put differently, if the yield on this new batch of 5-year debt had been the same as it was on the one it replaced, the annual cost over the next five years would have been $1.5 billion.
The auction for 2-year debt on May 28th generated a similar increase in the debt cost:
- The maturing batch, sold two years ago, was worth $54.1 billion and paid 2.45% in interest;
- The new batch, sold on May 28th, was worth $73.1 billion and will pay its owners 3.55% over the next two years.
As a result, the Treasury saw its debt cost for this batch of 2-year debt increase from $1.32 billion per year to $3.55 billion.
There is more of the same coming—a lot more. The next seven batches of 3-year Treasury notes that mature through the rest of the year are worth a total of $491.7 billion. The average yield on these batches is 0.53%, which means that the yearly cost for this segment of the federal debt is $2.63 billion.
If these seven batches of 3-year debt are replaced at 4.5%, i.e., if the Treasury does not sell any more debt than absolutely necessary to just roll over this debt, then, at the end of the year, their annual cost for this debt will have risen to $22.1 billion—a debt-cost increase of more than eight times.
The next eight batches of 7-year Treasury notes that mature from now through December are worth a total of $243.9 billion. At an average yield of 2.1%, they cost the U.S. Treasury $5.1 billion annually. Assuming again that this debt is just rolled over, and that the average interest is the same as it was at the auction in April, the average debt cost will more than double to $11.2 billion.
Similar calculations for the 10-year Treasury note point to an increase in the annual debt cost of $15 billion, or more than 500%.
These examples are concentrated on the debt rollover that will happen through the remainder of 2024. There is no explicit assumption of rising debt in these estimates, which of course is a bit naive; if we have learned anything from the past nine months of this fiscal year, it is that the federal government will increase its debt by at least $100-150 billion per month.
To get an idea of just how much the debt expansion plays into these numbers,
- The 2-year batch of debt sold on May 28th was 35% larger than the maturing one it replaced;
- The 5-year batch was 64% larger than the one it replaced;
- The 1-year batch auctioned on May 14th was more than 25% larger than the maturing batch;
- The last five batches of 10-year notes have been 88-97% larger than the ones they replaced.
To make a long story short: the U.S. government has seen its debt cost rise precipitously in the past year—and that was only the preamble.
