Evening Brief – 05.22.23
At least in the short run, the debt ceiling debate is not likely to have a big effect on the economy. The market is of the opinion that the US government will most likely resolve this issue, and market indicators hint at a small 1% per year probability of US debt default over the next five years, compared with the debt ceiling crises of 2011 and 2013.
The deadlock hasn’t had much of an effect on US borrowing costs, which have slowly been trending lower since the end of last year – in line with inflation. In addition, the US stock market has been in an uptrend since October 2023.
The reasonably positive view is probably because the epidemic significantly improved the economics of the US budget, allowing the US to obtain low financing rates while printing money to create inflation, accelerate GDP growth, and increase federal tax revenue.
But given higher interest rates, a return to more normal levels of inflation and a tepid economy, this upward trajectory is quickly worsening.
Additionally, this is clear when looking at the total debt level as a proportion of GDP, which is now 125%. After the pandemic’s initial spike, debt-to-GDP progressively decreased before beginning to rise again.
We are getting close to a turning point where the combination of rising debt levels, rising financing costs, and a lagging economy could lead to an exponential problem.
The debt ceiling can currently be continually raised since the US has the ability to issue its own currency. But the cost of servicing that debt as a share of US federal government revenue (taxes) is an important indicator for determining its sustainability.
The current debt limit is $31.4 trillion. As we retire older, cheaper debt and replace it with more expensive new debt, our debt-to-GDP ratio will skyrocket. According to Congress, we will need to issue an additional $130 trillion over the next 30 years, amounting to nearly 200% of GDP. Interest payments would absorb roughly half of federal revenue at that level and a 4% financing cost.