The U.S. government keeps borrowing money at alarming rates. This has been going on for a long time, but the growth in the debt over the past 12 months is beyond anything we have seen, with the pandemic as the only exception.
As a political economist, it is part of my job to analyze government finances. It may be hard to believe, but it can be a scary experience. The latest numbers on the federal government debt, provided by the United States Treasury, belong in that category.
October 1st last year marked the start of the 2023 fiscal year. On that day, the federal government had a debt of $30,929 billion. That also reads as $30.9 trillion, or $92,657 for every man, woman, and child in America.
As the 2023 fiscal year draws to a close (its last day is September 30th), we revisit the debt pile. On September 15th, with two weeks left of the fiscal year, the government owed $33,045 billion, or $33 trillion, or $98,534 per capita.
If we set up a payoff plan for this debt, every American who is employed today would on average have to pay $6,884 in a debt-payoff tax to the federal government. That comes on top of all other taxes—every year, for 30 years.
That amount does not even include the interest payments.
But wait: there is more. As the numbers above show, the federal government increased its debt by $2.1 trillion in one year. This 6.8% increase in the debt is beaten only by the increase in the debt during the 2020 pandemic.
To put this in even more perspective, in its latest forecast for government spending, the Office of Management and Budget, OMB—the White House’s own fiscal resource—predicts that the federal government will spend close to $6.4 trillion this year. This means that when the 2023 fiscal year ends, Congress will have borrowed approximately one-third of all the money it spends.
One-third.
The $2.1 trillion in new debt is a screaming warning about the recklessness with which U.S. government finances are being mismanaged. Perhaps the worst part of this is that there is practically no debate in Congress about this; the most conservative wing of the Republican House caucus is working hard to convince the rest of their party to push for greater fiscal responsibility, but to date, the resistance to such measures has been insurmountable.
To put some practical aspects on the debt growth over the past year:
- We have spent $2.1 trillion that we did not have, on everything from Ukraine-bound military aid to federal subsidies for school lunches; and
- We have decided that our children and grandchildren are going to pay the bill for all this.
As if the payoff cost of the debt was not enough, there is also its running cost, i.e., the interest rate. The debt consists of Treasury securities, in other words, bills, notes, and bonds that the Treasury issues and sells on the market for sovereign debt. The Treasury offers its debt to both individuals and institutional investors, although doing so is obviously not cost-free. In order to convince lenders to trust the federal government with their money, the Treasury has to pay interest on its securities.
Historically, the interest on the debt has not been a major fiscal issue. That has changed. Over the 2023 fiscal year, the interest payments on the federal debt have increased by a staggering 61%. For every $100 that the federal government paid its creditors in the 2022 fiscal year, it paid $161 in FY2023.
The total cost of interest on the debt is now within a hair’s breadth of reaching $1 trillion per year. For comparison, looking again at numbers from the OMB, U.S. defense spending will total $815 billion for 2023. The federal government will spend $836 billion on Medicaid (health insurance for low-income families) and $830 billion on Medicare (health insurance for retirees).
The only single item in the budget that will be bigger than interest on the debt is the retirement-benefit program Social Security. Its total cost will top $1.3 trillion in 2023. However, if the federal debt continues to grow as it has this past year, and if the interest cost on the debt continues to rise as it has now, that cost item will become the largest in the budget already next year.
Already now, the rising interest cost on the debt is a main contributor to the budget deficit. The federal government is at the point where it has to borrow more money simply because it has already borrowed money.
In the world of public finance, we call that ‘rocketing your country into a fiscal crisis.’
But will this sensational scenario become true? Will the federal government’s bill for debt-incurred interest payments actually become the biggest item in the budget?
If we asked most economists who analyze the federal government’s finances, they would almost in unison tell us that this will not happen. One reason they would give is that interest rates are not expected to rise as quickly last year as they did this year. This will stabilize the cost of the debt.
They have a point. Over the past year, interest rates have indeed risen like they have not done in decades. In October last year, the interest rate on the U.S. debt was 1.87% on average; now that the fiscal year is drawing to a close, that average rate is 2.82%.
In the past 12 months, rising interest rates have accounted for more than 80% of the increased cost of the debt. This means that the rise in the debt itself, scary as it is at $2.1 trillion, is the minor reason why the debt cost has gone up as it has.
Based on this observation, it is tempting to conclude that the interest cost on the debt will stabilize over the coming year. Up to this point, the Federal Reserve’s monetary tightening has been the main driver of the rising interest rates. Its campaign against inflation will come to an end soon, which means that the main force that pushed interest rates up in 2023 will be gone in 2024.
As tempting as it is to assume that this means stable interest rates next year, it would be premature, even imprudent, to draw the conclusion that this will actually happen in 2024. The reason for this is simple: All it takes for interest rates to keep rising is that Congress keeps borrowing money.
When a government builds up a pile of debt, those who invest in that debt obviously monitor how fast the debt is growing. A major benchmark for assessing the severity of the debt is the debt-to-GDP ratio. It is a good general rule of thumb that the gross domestic product, GDP, is the broadest possible tax base that a government can use in order to obtain the necessary revenue to pay interest on its debt.
Plain and simple, the larger the debt grows relative to GDP, the harder it will be for the indebted government to collect enough taxes to pay the interest costs. Investors notice this and, at some point, decide that the rising debt-to-GDP ratio necessitates demands for higher interest on the debt.
At the beginning of the 2023 fiscal year, the U.S. government’s debt-to-GDP ratio was approximately 120%. Preliminary estimates indicate a rise in that ratio over the past year: the ratio will probably exceed 122% by the end of this fiscal year. This is not a dramatic increase, but it is important to keep in mind what has driven the growth in GDP over the same period: inflation. Now that prices do not rise at nearly the same rate, the growth in current-price GDP will slow down considerably.
The inescapable truth in this is that if Congress keeps borrowing with its usual frivolity, then, over the course of the 2024 fiscal year, the debt-to-GDP ratio will grow faster than it did in FY2023. As a result, investors in U.S. debt will demand higher interest rates just to keep buying it.
We have now reached the point where the size of the debt itself can drive up deficits and thereby the accumulation of more debt. This is a far more dangerous debt-inflating force than when the Federal Reserve was behind the rise in interest rates. Once debt-market investors start demanding higher interest rates, it is very difficult to stop the rates from rising. The only way that Congress could do so, would be to engage in major spending cuts within a short period of time—in other words, the same type of austerity policies that wrecked the Greek economy a decade ago.
At this point, there is no sight of any such policies even being considered in Congress, let alone more prudent, farsighted measures to curb spending. President Biden and his administration seem to be equally uninterested in preventing market-driven increases in interest rates. One indication of this is their debt management policy, which I have pointed to in the past: when the Treasury needs to borrow more money, it issues new debt under short-term maturities, which—due to an inverted yield curve—come with higher interest rates than longer-maturity debt:
- Since October last year, the Treasury has borrowed $2,124 billion in short-term debt with a maturity of one year or less;
- This amount exceeds the total increase in the U.S. debt for the same period of time.
The share of the debt that is held in short maturities has increased from 15% at the start of the fiscal year to 20.6% as of September 15th.
It is incomprehensible why the Treasury has used short-term bills instead of long-term notes and bonds to borrow more money. Yet it is a fact that they have, and that they are continuing to feed the sovereign debt market with high-yield debt securities. This is a clear signal that the Treasury has no long-term perspective whatsoever on how to manage the federal government’s debt. Therefore, it is inconceivable that they will take any policy measures to slow, let alone reverse, the rise of the debt.
Meanwhile, as is visible in the Treasury auctions of new debt, the sovereign debt market continues to drive rates higher. Some examples:
- In the past 12 weekly auctions of the 1-month Treasury bill, the median yield, or interest rate, has risen from 5.02% to 5.27%; six months ago, the auction yield was 4%;
- The six-month bill has been paying more than 5% at auctions for 18 weeks straight; the yield at last week’s auction of 5.29% was a recent record;
- The five-year note, which the Treasury auctions off monthly, paid 4.33% at its most recent auction, the highest yield in at least six years;
- The benchmark 10-year note set a record for at least ten years by paying 4.23% at its latest monthly auction.
While the market push on interest rates is slow, it is nevertheless happening. Regardless of whether the Federal Reserve continues to raise interest rates, private investors will continue to demand higher interest rates simply because the debt keeps rising. If, on top of that, the U.S. government suffers another credit downgrade—and I would expect more to come—the pace of rising yields will pick up.
The 2023 fiscal year is not one that Congress, the president, or for that matter American taxpayers should be very proud of. On the contrary, the best way to look at it is a missed opportunity to come to grips with a debt problem that sooner rather than later will become an existential threat to the prosperous U.S. economy.
