Congress and the Biden administration don’t seem to realize that inflation is as “temporary” as they’ve been telling us, meaning it’s likely to continue for quite some time. Why is this important? Just ask anyone who’s ever been attracted to an adjustable-rate mortgage, where you start out with a low interest rate and quickly increase your interest rate as conditions change.
The yield on the 10-year Treasury note has soared to 4.8% in the past month, well above the prevailing interest rate over the past 16 years. Meanwhile, two-year Treasury bills are yielding 5.2% and three-month Treasury bills are yielding 5.5%, far higher than the Congressional Budget Office expected in February. ing. For this quarter, CBO assumed a 10-year yield of 3.9%. Currently it is 4.7%.
Rising interest rates may not be a concern for people who lock in low interest rates on their mortgages or auto loans, or who invest wisely in government bonds. But the latest interest rate hike will be painful for the federal government, which has borrowed heavily for short periods of time.
Most households have wisely protected themselves from interest rate fluctuations. The Wall Street Journal reported in July that a Moody’s analysis found that “only 11% of household debt had interest rates that fluctuated with the base rate.” Americans learned the risks of floating interest rates during the last recession. The government did not do that.
The average maturity of U.S. Treasuries is just 73 months, according to the latest Treasury Department data. One-third of this debt has a maturity of one year or less, and 53% has a maturity of three years or less. This means that half of it has to be rolled over in a very short period of time, and you have to pay it back and borrow again, only to get higher interest rates. That’s a big deal considering the ever-growing $25.8 trillion debt.
If you follow this, you’ll see that as interest rates rise, the cost of servicing debt increases. CBO’s monthly budget review highlights the scale of the problem. It expects to pay $711 billion in net interest this fiscal year. Add to that the Federal Reserve’s $100 billion operating loss in fiscal year 2023 — as Chris Russo, chief economist at the Committee on the Integrated Economy, suggests it should do — and you’re talking about $810 billion. It becomes a dollar. This is equivalent to 3.1% of U.S. GDP and more than double the amount of interest paid last year.
On average, current interest rates are about 1 percentage point above those assumed in the CBO’s baseline. But what if that gap persists over the next decade? That would add an additional $2.8 trillion to the debt, on top of the $45.2 trillion that governments will accumulate by 2033.
Now, what if increasing debt without an actual repayment plan has no economic impact other than slowing economic growth, increasing the risk of financial crisis, and reducing the ability to respond to emergencies? But it’s bad enough), the CBO projects that the net interest will be consumed. By 2053, it will account for 23% of spending and about 40% of federal revenue.
Think about it.
What if your home, car, and credit card payments alone accounted for 40 percent of your wages and a quarter of your expenses, excluding principal, taxes, and insurance? Forget about vacations, restaurants, and even proper housing, food, and medical care.
This scenario depicts a government in financial distress. Now imagine our government having to make difficult choices, say between national defense and social welfare.
However, the reality is even crueler. Academic research shows that for every 1 percentage point increase in the debt-to-GDP ratio, real interest rates rise. In other words, higher interest rates lead to higher debt, higher debt leads to higher interest rates, and so on. Moreover, it is completely unrealistic to predict that increasing the debt from 97 percent to 181 percent of America’s GDP will not drive inflation higher.
Although inflation is currently falling, it remains uncomfortably above the Fed’s 2% target, making it too early to declare victory. Indeed, if these increases in interest payments are paid for by more borrowing rather than spending cuts or tax increases, as CBO expects, there is a risk that inflation will pick up again. That would require further rate hikes, setting us on a messy path similar to the 1970s and 1980s. The difference is that debt back then was only 25% of GDP.
Get that picture? If Congress continues to refuse to cut spending, we could be in even worse pain than we are currently suffering.