As the three major US indices race to newer heights, it is all the more alluring to ignore the warning bells that went off as recently as August last year.
Fitch Ratings, one of the most reputed and prestigious rating agencies in the world, flagged US debt and downgraded its rating from AAA to AA. Just so that one comes to terms with the significance of the downgrade, please bear in mind that US treasuries have retained the original AAA rating since 1994.
The rating agency marked out that the downgrade was on account of rapidly growing debt burden, a fall in governance standards and the fiscal deterioration that will, in all likelihood, follow from the ballooning debt burden.
What is the total US debt burden?
As of December 2023, the total US debt burden stands at an enormous, nearly unimaginable $33.1 trillion. The figure is a consequence of misplaced economic policies that encouraged expenditure, over a pronounced emphasis on savings and higher exports.
Since 2001, the US government has spent more funds than what its economy has been able to generate. Consequently, the difference between spending and income generation is being bridged by funds raised from the markets.
To be fair, the US national debt situation wasn’t this alarming till the advent of the pandemic.
Since the appearance of the Covid crisis on the global scene, US national debt has widened by an intimidating 89%. While it is true that a country must not fret over debt in the middle of a crisis, it must– after the passage of adequate time– refocus its attention on dragging down its debt levels, and improving its inflows.
There are many advantages to keeping the debt levels of an economy under check: Most importantly, it encourages more investors to lend funds to the government, while the government benefits from raising funds at a competitive rate.
As per Financial Times, bond debt issuances in the US in 2024 are likely to surpass the $4 trillion mark, up from $2.3 trillion in 2018 and $3 trillion in 2023.
If one thought that the UK might be performing much better, then, they are mistaken. The UK isn’t faring much better either. The Bank of England will be selling the second-highest level of debt security since 2020.
The making of a perfect storm
Excessive leverage for countries does not bode well– neither for their people, nor for the economies.
In the US, the fiscal deficit– the difference between the income and spending of a government- is set to hover in the 6.5% to 8% of the GDP range over the coming four years, as per IMF predictions. This elevated fiscal deficit will stand in sharp contrast to the 4% deficit reported in 2022.
Quite naturally, with massive debt comes a taxing interest burden on the economy. Interest payments will also eat away a progressively larger chunk of the national income. By 2028, the US interest burden is predicted to account for 4.5% of the GDP vis-a-vis less than 3% in 2022.
How does ballooning US debt impact the markets?
Not many would contest the fact that the US occupies the position of the global leader. Its geopolitical might, and its unlimited arsenal are deeply interwoven with its economic muscle. However, with increasingly burdensome interest payments, investors are reluctantly waking up to the idea that the US government’s inability to service its debt can trigger a worldwide recession.
This, in turn, will prod a flight away from equities, and towards safe yet traditionally conservative options like gold and land.
Till now, the US treasury bonds were considered risk-free investments. However, in a world where US debt servicing imposes greater national costs, the economic consequences can be harmful, for individuals and private companies alike.
As per Goldman Sachs Global Investment Research, continued fiscal deficits will likely raise the US debt-to-GDP ratio to above 120%, a level last breached in World War II when the ratio crossed 106%.
The only way the US can signal fiscal sustainability to millions of its bond investors around the world is to re-calibrate its focus on boosting its GDP growth in relation to its interest burden, and secondly by inculcating fiscal responsibility across the political class.
However, in a constantly shifting geo-political paradigm, where the might of the US is being challenged in the Red Sea or Ukraine, the prospects of fiscal responsibility look increasingly difficult.
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