The US Debt Ceiling Crisis: What You Need To Know
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It’s a story as old as Capitalism. Downtown, the borrower frets over their next loan payment. They’re strapped and don’t have enough cash to meet their current payment. If they’re not careful, they’ll go into default, and no one is quite sure what that would mean.
While across town, the Bankers are meeting, deciding how much interest they should charge on their loans. Let’s raise it another quarter percent, declares the Chief Banker, Jerome “Snively” Powell.
Wait, someone shouts, Ole man Biden, and Kid McCarthy, say they’re out of money. If we increase rates, they won’t be able to meet their monthly payment.
“Forget Biden,” says Powell as he heads out the door, “I’m on an Inflation Crusade.”
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Of course, the above story Is purely fictional, or is it? Although some of the names have been changed, the fact remains that on May 9, the borrower, that’s you and me, and the Federal Government, represented by “ole man” Biden and “kid” McCarthy.
Consider the irony, this week, the US Central Bank, or the Federal Reserve, met to set interest rates. While, next week, President Joe Biden has invited Kevin McCarthy to the White House to discuss the growing financial crisis. A crisis was created because the US does not have enough cash to pay its monthly Debt payment.
As you know, the Fed raised interest rates by another one-quarter percent. The question that needs to be asked, but seldom is, is what does that interest rate move do to our National Debt payments?
It is the critical flip-side of the Fed’s current interest rate tightening. The answer: the latest one-quarter percent hike will raise the interest on our national Debt by $80 Billion. In other words, our annual debt payment has increased by an additional $80 billion annually and will now be added to our country’s indebtedness.
Now, I hear a lot of discussions that this action by the Federal Reserve is just like what Paul Volcker’s Fed did back in the 1980s. However, a review of the actual numbers reveals significant differences between the actions of the 1980s Fed and today’s Fed.
First, the actual move in interest rates was far less under Volcker, and it is under Powell today, in percentage terms. Although Volcker’s terminal rate was spectacular, at 19%, he began with an elevated interest rate of 5%. So the Volcker Fed hiked rates by 400%. And they held that high rate for only seven months. After which they immediately dropped rates in half to less than 9%.
Today the Powell Fed has raised interest rates from one-quarter percent to 5 1/4%; in percentage terms, that’s a move of 2,100%, far greater than Volcker’s move. Assuming that the current level is the terminal rate, it will be interesting to see how long the Powell Fed holds this rate.
Let’s see the effect on our national Debt the two Fed’s actions would have. To make this comparison equal, I’ll make a couple of assumptions. 1. That the interest rate for the US Treasury markets has the same interest rate hike as the Fed Fund’s rate. 2. That already issued Treasuries also rise at that same rate. We know that some existing Treasuries will “roll over” later, but for this discussion, we will assume they all “roll over” together.
So, in 1980, when Volcker raised rates by 14%, the Federal Government Debt was less than $900 Billion. In our model, Volcker raised the interest on our Debt by roughly $126 Billion.
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Today, our Federal Government Debt is $37 Trillion, and Powell’s interest rate hike will add $1.94 Trillion to our Debt. In other words, the recent hike in interest by the Fed will increase our annual debt payment by an amount that is nearly double the nation’s total Debt in 1980. Or another way to visualize this, the Federal Reserve’s rate hikes have cost us almost 9% of our real Gross National Income (GNI) in additional debt payments.
These interest payments are becoming so significant that they have a tremendous impact on the economy. We need to pay attention to the fact that each interest rate hike by the Federal Reserve substantially impacts our Debt payments. And as the largest debtor nation on the Planet, this will continue to impact our economy for years to come. That’s our first great fantasy.
The following fantasy is that President Biden and Speaker McCarthy will discuss the “Debt Ceiling.” Although that’s what it’s called in reality, it will be a discussion of how far we can “kick this can down the road.” Neither of these gentlemen nor anyone in Washington intends to meet and fully pay our Debt. Yes, partial payments will be made, but just enough to maintain a semblance of credibility. But when they propose a $5 Trillion Budget, they know there is no way this country could support that level of spending.
In the world of Washington, there is no ceiling to our Debt. This newly created deficit will be added to our already existing $37 Trillion Debt. A burden that the American people will bear for a generation or more.
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