I encourage readers to visit the website usdebtclock.org. The site itself is beautiful, with multi-colored numbers all moving at once as compound interest affects the nation’s financial condition, and the bigger the monitor, the more mesmerizing the optics.
Unfortunately, under all the beautiful moving numbers is actual real money and real math, all presenting a concerning reality.
As was made quite clear by Federal Reserve Chairman Jerome Powell last week, the central bank intends to begin raising short term interest rates next month. As is typical, this expectation has got Wall Street in a tizzy, as investors attempt to price stocks in the context of these new higher interest rates. Every pundit has an opinion as to how many 0.25% interest rate hikes the Fed will execute during this tightening cycle, with the most analysts coming in between three and seven rate hikes over the next year to 18 months.
With inflation dominating the headlines, I do not think the Fed’s rate hike plans will be deterred by the prospects of the mid-term election cycle this year. Inflation must be tamed; rates are going up. Someone must “do something.”
With this rate hike certainty in mind, let’s go back to the debt clock and do some really huge, but simple math, but I’m warning you, the math is ugly.
After two expensive wars, a financial crisis, a viral pandemic and just a general inability to manage itself, the federal government has now accumulated debt of over $30,000,000,000,000. Now, government debt is complicated, as government finances do not resemble household or corporate finances, and so we need to be aware of this when we start down this road.
Some of the money the government owes is owed to itself, some of the money is owed to the Federal Reserve, which kind of recycles the interest payments back to the government, some of it is owed to the Social Security system at very attractive terms. Some, however, is owed to pension funds, and to big banks and yes, to the Chinese. Regardless of who is actually owed the money, the debt itself is in some form of security (bond or note) and these securities all have to pay interest to their owners.
When we go back to the debt clock, there are some other interesting numbers moving on the screen. Right now, as short-term interest rates are near zero percent, the yearly net interest on the $30 trillion national debt is about $425 billion, or about 1.4%, of the $30 trillion. This isn’t a bad rate, and fortunately the U.S. government expects to collect about $4 trillion in tax revenue, so as a percentage of the money the government has coming in, only about 10% is going toward interest, which once again, isn’t bad.
Remember, however, the Fed is dead set on raising interest rates to address inflation. Since the number of hikes to expect is debated to be between three and seven, let’s split the difference and assume we get five rates hikes during this part of the cycle, which will see short term interest rates go from zero percent to 1.25%. Once again, doesn’t seem like a big deal.
If, however, we assume the spread between short term rates and the rate of interest the government pays on its securities stays the same as it is now (1.4%), therefore increasing interest payment on the total national debt, logic would tell us that we would expect this aggregated net interest cost to go from 1.4% to 2.65%. If this assumption were to come to pass, this would mean within 18 to maybe 48 months the interest the federal government has to pay on its debt would go from $400 billion to around $800 billion, and this assumes no new debt is created over this time period.
Big, simplified math once again tells us if the government collects $4 trillion in taxes, and owes $800 billion in interest, this small move in rates takes double the amount of tax revenue to service the national debt.
What does this mean? Well, if you think the government can just raise taxes on the “rich” to solve this math problem, the truth is the rich simply don’t have the money. If you think the government can just “tighten the belt,” we all know it's not so good at that, and besides the only nonstructural place to find these types of savings would be defense spending, and we all know that is not likely to happen.
Look back at the political rhetoric of the last 30 years. We all knew this math was coming, and after COVID, it looks like it's here. I don’t have any answers, and the scary part is, I’m also pretty sure no one else does either.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.