Recent anguish over raising the United States Congress’s wholly arbitrary debt ceiling by summertime, to avoid forced budget cutting, obscures a number of issues. In all likelihood, the debt ceiling will be raised and the military, pensioners and other core U.S. federal spending will not be endangered – although, beforehand, there will be political hysteria and alarmism. This enormous debt is a problem, and should be addressed, but it is not ‘existential’, as the Climate Alarmists like to say.
The larger questions involve the fast-growing federal debt itself, the even-faster-rising costs of servicing that debt, and the relative value of the U.S. dollar (which is the dominant global reserve currency and medium of exchange). The U.S. federal debt has risen to a higher proportion of GDP, now being more than one hundred percent – this is higher than ever, even more than during and just after World War II.
Firstly, the U.S. dollar still occupies the top spot in the reserves of foreign nations; representing now over half of all such reserves. However, that share is declining, as it has been for years. The euro is taking up most of the ground the greenback is ceding. The Japanese yen is the next largest reserve currency, and the UK pound is a distant fourth. (The Chinese yuan (or renminbi) and the Indian rupee are constrained by capital controls.)
In the short term, relatively high (versus recent past) yields on government and corporate debt in the U.S. will persist – particularly compared to Europe or Japan yields. Institutional investors (domestic and foreign) are inclined to stash substantial portions of their portfolios into ‘quasi-safe’ U.S. bonds. (Since U.S. bond markets are huge and very liquid (traded frequently with little risk of not being able to sell at recent prices), they remain the first choice for parking medium-term funds.)
Recent high U.S. federal deficits are not the result of paying for established government programs, but rather for meeting politicians’ shorter-term grandiose projects. Being impermanent fixtures in government outlays, they are cuttable or revocable, and most investors recognize this.
The former British Empire declined in power, economic vigour and its currency wilted, but that does not necessarily presage the U.S. fate. It remains militarily and technologically powerful – with the world’s most diverse and innovative economy (including energy, mining, agriculture).
Thus, the currently soaring U.S. debt is relatively temporary and manageable. Nonetheless, earlier former dominant powers were similarly complacent. Current U.S. projections show short- and longer-term rates will stay well above three percent. When older, low-yield debt is rolled over at higher rates, annual U.S. federal debt servicing cost could hit one trillion dollars, equalling the worst of pre-Covid deficits.
This alone will be a major drag on the U.S. current account, and capital inflows may only finance it via the U.S. dollar dropping in value, making U.S. export sales more attractive and its imports more expensive. U.S. interest rates may need to rise further to make the currency risk worth taking for some bond investors.
While a dramatic U.S. currency or debt crisis may not be imminent, a longer-term painful period of U.S. adjustment and belt-tightening is likely unavoidable. Its biggest trade and investment partner, Canada, is also vulnerable, and could face hardship, too.
Ian Madsen is the Senior Policy Analyst at the Frontier Centre for Public Policy