I never thought I would issue this warning, but I have to: the United States government is at risk of a debt crisis like the one that Greece went through a decade ago.
The risk is not imminent, but high enough to alert everyone with any interest in the debt market, the U.S. currency, or for that matter the U.S. economy as a whole.
This is not a general pundit-based alarm bell going off. This warning is based on hard numbers.
Let me get to the numbers in a minute. First, it is important to note that the main reason for this crisis is that the U.S. government has spent exorbitant amounts of money by borrowing from the Federal Reserve. The central bank, in turn, has printed excessive amounts of money, allowing the debt cost to plummet to virtually nothing.
The monetary policy has changed, but Congress continues to spend as if nothing has happened.
It has. Already back in June last year, I warned that major central banks, such as the Federal Reserve, the ECB, and the Bank of England, had exhausted their ability to purchase government debt. At that time, the Federal Reserve had already begun raising interest rates, while the ECB and the Bank of England were late to the game. They came around later last year, with other central banks following suite.
The upside of this shift in monetary policy is that inflation is coming down again in most countries. The downside—at least from the viewpoint of governments that want to spend a lot of money—is that central banks can no longer accommodate excessive deficits.
Back in October I warned that in the last quarter of 2022, the U.S. Treasury would have to
refinance at least $2.4 trillion in short-term debt. They will have to pay interest rates that are up to 27 times higher than on the debt that is being refinanced.
This is the so-called debt rollover effect. Suppose that five years ago, you bought $100 worth of U.S. debt with a maturity of five years. The interest that the U.S. Treasury pays you is, say, 0.5%. When that security matures, you get a check for $100 from the Treasury. To be able to pay you that $100, the Treasury sells another $100 to someone else, only this time they have to pay 5% for the next five years.
The rollover effect is causing a debt-cost bomb to go off, in slow motion. Over the past six months, the U.S. Treasury has rolled over trillions of dollars worth of low-cost debt, seeing its cost for interest on that debt rise precipitously. The average rate on the entire $31.5 trillion federal debt has gone up from 1.87% on October 1 last year (when the 2023 fiscal year started) to 2.4% today.
This is a 28% increase in the debt cost, and it has happened in just six months. But it is only the beginning: the Treasury still has over $9 trillion of debt that currently costs them 2% per year. Almost half of that costs them less than 1%.
Here are the grim details of what the U.S. Treasury is facing.
In the next 12 months, it will have to roll over $799 billion worth of 2-year Treasury notes, almost all of which costs less than 1%. There is also $689 billion in 3-year notes coming due, all of which currently costs the Treasury less than 0.5%. Almost $257 billion worth of 7-year notes coming due in the next seven months, currently paying 1.5%
Based on recent auctions, they will have to pay 4.1-4.6% to roll over that debt.
Then we have the debt under other maturities, currently costing 2-3%, and of course the new debt that the Treasury will have to sell in order to continue to fund ongoing deficit spending.
These are estimates under the assumption that interest rates do not rise any further. The Treasury is already paying 4-5% on the debt it sells at auctions, consistent with the rates in the secondary market for U.S. debt (sometimes referred to as the ‘open’ market). However, in the secondary market, where investors buy and sell existing debt, interest rates are already above 5% for U.S. debt that matures in 4 months to 1 year. This market is usually ahead of the auctions where the Treasury sells new debt, which means that the U.S. government can look forward to paying higher rates than they already are.
If the current trend in interest rates continues, and if Congress continues to spend on deficits at its current rate, the total cost of the U.S. debt will exceed $1 trillion for this fiscal year. In 2021, that cost was $562 billion, so we are talking about a staggering increase. In fact, if my prediction is correct—and so far it has proven to be right on target—by the end of September when the fiscal year ends, the cost of the debt will exceed every other item in the federal budget, except the pension and disability benefits program known as Social Security.
I sounded the alarm over this exploding debt cost long before others did, but I am pleased to see others speaking up. One of them is the Congressional Budget Office, CBO, the budget analysis outfit at the U.S. Congress. According to Fox news, on March 1 the CBO director informed a group of Republicans in Congress and, as we say in America, read them the riot act:
“The CBO made it clear that the level of growth necessary to balance the budget without cutting spending is impossible,” a GOP aide told Fox News Digital. They said [CBO Director] Swagel told the lawmakers, “We cannot grow ourselves out of this.”
In other words, the CBO explained that:
a) the debt-cost problem is rapidly growing out of control, and
b) Congress cannot rely on economic growth to fund that cost with more tax revenue.
Fox News also cites another source, conveying the same message:
Swagel shared dire warnings about the U.S. economy if serious fiscal cutbacks to fix the deficit are not imposed.
In its latest outlook on the U.S. debt, the CBO predicts that the debt cost as a share of GDP will double in the next ten years. In static terms, i.e., without any growth at all, this would raise the debt cost from my predicted $1 trillion for this fiscal year, to $2 trillion. That cost hike would force the federal government to raise taxes on individuals and corporations by 27%—and the bulk of that burden would fall on small businesses, and on families with moderate incomes.
Plain and simple, it would be economically catastrophic. Yet without structural spending reforms to deal with this situation, the crisis is inevitable.
However, the outlook for the U.S. economy is not the most alarming part of this. The biggest threat right now is that investors in the market for sovereign debt will move away from U.S. Treasury securities, much like they did with Greek government debt in 2009-2011.
There are signs that this is already happening. They are hidden in some technical metrics, related to the auctions for new U.S. debt.
At these auctions, the U.S. Treasury invites investors to make tender offers, i.e., announce how much money they are interested in spending. Last week, e.g., at the weekly auction for debt securities with a one-month maturity, the Treasury got $190.9 billion in tender offers.
The Treasury goes into every auction with a plan to sell a certain volume. When the auction is finalized, the actual accepted volume is announced; in last week’s one-month bill auction, that volume was $76.3 billion.
When we divide the tender offer by the accepted volume, we get the T/A ratio, which is a good tool for measuring how ‘interested’ investors are in U.S. debt. In the aforementioned auction, this ratio was 2.5, meaning that investors offered $2.50 for every $1.00 worth of debt that the Treasury wanted to sell.
If the T/A ratio is rising, the Treasury has reasons to be happy. They can sell their debt without having to pay very high interest rates. If, on the other hand, the ratio declines over time, there are reasons to be worried. And that is precisely what is happening:
- A month ago, in early February, the weighted average T/A ratio for the U.S. debt was 2.64;
- Last week, it had fallen to 2.22, and showed no signs of increasing again.
The plain and simple message in these numbers is that investors are offering the U.S. Treasury fewer dollars for every dollar of debt that the Treasury wants to sell.
In other words, the Treasury has reasons to worry. But it gets worse: while the T/A ratio has declined, the interest rates on U.S. debt have continued to increase. In one month alone, the average interest cost on the debt has risen from 2.3% to 2.4%. This may not sound like much, but let us keep in mind that the increase is driven just by the small share of the debt that is auctioned every month.
The open, secondary market for U.S. debt is a much more dire indicator of where the cost is going. On February 2, interest rates spanned from 3.4% to 4.76%, depending on when the security matures. On March 2, the rate span ran from 4.03% to 5.18%.
Currently, therefore, the U.S. Treasury is paying higher interest rates to keep fewer investor dollars interested in its debt. With interest rates already at or slightly above 5%, and with no signs that the rise in rates is ending, the Treasury has all the reasons in the world to worry.
So does the Congressional Budget Office. Not only do they predict—correctly in my mind—that the debt cost will rise to statically double in the next ten years, but they also predict that GDP growth will stay closer to 2% (adjusted for inflation) than 3%. This prevents tax revenue from ever catching up with federal spending.
Here, I believe the CBO is overly optimistic: they do not take into account research that shows that GDP growth is slowing down when government spending exceeds 40% of GDP. I would shave another 0.5% off the CBO prediction given that the size of total government spending in the U.S. economy is precipitously close to the 40% mark, and will—all other things equal—exceed that mark in the next year or two.
Furthermore, the CBO predicts that interest rates will stabilize at current levels. Despite that, they issue their warning to Congress. However, there is no reason to believe the current drift upward in rates will wane off: on the contrary, with investors growing increasingly weary of the debt outlook for the U.S. government, declining liquidity in the debt market—exposed by a rising T/A ratio—will continue to push rates upward.
If the current trend continues, the average rate on the U.S. debt will be in the 2.9-3.3% range by the end of September (compared to 2.4% today). This means that the highest rates, which are currently paid on the securities with short maturity dates, will exceed 6%.
All in all, the risk for a U.S. debt crisis is rising. If it strikes, it will do so with little warning; the best metric to see it coming will be that the T/A ratio falls below 1.5.
When it goes down below 1, it means that the Treasury can no longer sell all of the debt it needs to sell. That is the definition of debt default. I don’t see that happening—not now. But for anyone who wants the U.S. government to avoid ending up there, the current trends in the debt market are all pointing in the wrong direction.