In 2002, then-Vice President Dick Cheney made the assertion that “Reagan demonstrated that deficits are inconsequential.” Subsequently, he advocated for tax cuts alongside increased federal spending.

The Bush administration followed suit by initiating substantial expenditures, such as a significant expansion of Medicare and allocating hundreds of millions of dollars towards costly and purposeless military occupations in Iraq and Afghanistan. Throughout Bush’s eight-year tenure, the national debt surged by 70 percent, yet this escalating concern failed to stir significant interest among politicians in Washington, regardless of their party affiliation. Following 2003, as the economy appeared to be flourishing, the paramount focus after the 2008 financial crisis became rescuing Wall Street to salvage the global economy.

In truth, for over three decades, austere admonitions about the federal debt and yearly deficits emanated from pessimistic individuals who insisted that accumulating immense debts would eventually present problems. They were correct, but the actual timeframe for these issues to materialize proved to be considerably longer than anticipated. Numerous consequential geopolitical and economic developments intervened, mitigating the repercussions of accumulating an astronomical national debt. During the period from 2000 to 2019, the total debt swelled from $5.6 trillion to $22.5 trillion. These transformations encompassed an upsurge in global productivity, the emergence of a globalized labour force, and robust worldwide demand for the US dollar, thereby generating a seemingly boundless appetite for US government bonds. As a result, managing the debt remained relatively straightforward, albeit temporarily.

However, the tide is turning, and in the next five years, we will witness the unfolding of a paradigm shift. A rapidly escalating debt, diminishing demand for the US dollar, and mounting inflationary pressures will unveil the undeniable significance of deficits. The prevailing notion that deficits are inconsequential will be challenged, prompting a reassessment of the consequences of fiscal irresponsibility.

How Much Debt Are We Talking About?

As we look at the current scenario, it is alarming to observe the trajectory of the US national debt, which is now projected to surpass $32 trillion in 2023. This represents an increase of nearly ten trillion dollars since January 2020. Astonishingly, almost eight trillion dollars of this surge occurred within the span of 2020 and 2021 alone. The rate at which the US government has been accumulating new debt has escalated significantly since 2019, surpassing an already staggering pace of deficit spending.

In 2019, it was noteworthy that the Trump administration had added close to a trillion dollars to the deficit in a single year, even during what was considered an economic expansion. However, the subsequent events under both the Trump and Biden administrations during the COVID-19 pandemic made that trillion-dollar figure appear trivial in comparison.

Additionally, the debt-to-GDP ratio has reached unprecedented heights since the post-World War II era. In 2020, the total federal debt as a percentage of the national GDP skyrocketed to 120%, marking previously unseen levels of peacetime debt for the United States.

These figures paint a concerning picture of the nation’s fiscal health and raise important questions about the long-term sustainability and potential consequences of such elevated levels of debt.

 

While assessing the government’s capacity to repay and service its debt, relying solely on the debt-to-GDP ratio offers limited insights. A more practical gauge lies in comparing the total debt to federal revenues—a metric that provides a realistic perspective. Utilizing this measure reveals a troubling trend as the debt has surged to unprecedented levels during peacetime. Presently, the total federal debt exceeds six times the magnitude of annual federal receipts, underscoring the magnitude of the challenge in managing and addressing the debt burden. This stark statistic raises concerns regarding the government’s ability to generate sufficient revenue to cover interest payments and make meaningful progress in reducing outstanding debt. By considering the debt-to-revenue ratio, a clearer picture emerges of the fiscal landscape, prompting serious contemplation of the government’s capacity to fulfil its financial obligations.

This Translates Into a Lot of Interest Payments 

The magnitude of a large national debt does not pose an inherent problem in terms of size or difficulty in repayment. A government can sustain an enormous debt indefinitely as long as it effectively manages the interest payments. For a significant portion of the past three decades, the US government enjoyed relative ease in this regard. Despite incurring substantial annual deficits and accumulating trillions of dollars in new debt, interest payments on that debt remained remarkably stable and did not spiral into uncontrollable levels.

This favourable scenario was made possible by the persistent downward trajectory of interest rates over the past 35 years. Analyzing the federal funds rate, which typically aligns with the average interest levels paid on the federal debt, reveals a simultaneous surge in debt levels and a decline in interest rates. Consequently, the decrease in interest rates prevented a corresponding surge in interest payments.

The decline in interest rates can be attributed, in part, to the dominant position the US assumed in the global economy following the conclusion of the Cold War during the 1990s. This economic supremacy led to an increased demand for US dollars worldwide, with many holders of dollars choosing to invest in US government debt. This heightened demand effectively reduced the cost of issuing new federal debt. Even with the emergence of the euro after 1999, globalization played a crucial role in sustaining the global demand for US debt, alongside the eurodollar economy.

These circumstances created an environment where the government could manage a large national debt without experiencing immediate consequences, such as an uncontrolled surge in interest payments. However, it is important to recognize that economic conditions are subject to change, and factors influencing interest rates may evolve over time. Therefore, the dynamics of debt management could shift in the future, necessitating careful consideration of the government’s ability to address its financial obligations.

 

Following the financial crisis in 2008, the United States witnessed a further decline in interest rates on its debt, primarily due to the significant bond purchases conducted by the US central bank. With the central bank acquiring approximately six trillion dollars’ worth of US bonds, this artificial surge in demand for federal bonds contributed to a further decrease in interest rates. As a result, despite the substantial increase in the national debt during and after 2009, the burden of interest payments remained within manageable limits for the federal government.

 

From 1998 to 2015, an intriguing trend emerged as total debt service costs exhibited minimal fluctuations, despite the continual expansion of the national debt. However, this pattern shifted following 2017 when the Trump administration’s substantial deficits and the Federal Reserve’s decision to cautiously raise interest rates to mitigate concerns of inflation led to an upward trajectory in debt service costs. The turning point came in 2020 when interest payments on the debt surged above the threshold of half a trillion dollars. Projections indicate that these payments are expected to continue increasing in the foreseeable future.

 

Interest Payments Will Gradually Consume the Federal Budget

The inherent problem with colossal levels of debt becomes evident when we consider the heightened sensitivity of total debt payments to fluctuations in interest rates. In 2007, when the national debt amounted to a “mere” nine trillion dollars, the federal funds rate could increase beyond five percent without causing a substantial surge in interest payments. However, over a decade later, with debt levels soaring to $30 trillion, a comparable rise in the federal funds rate would lead to a much more significant escalation in debt service payments.

In practical terms, this signifies that a government burdened by a colossal debt load is unlikely to sustain substantial increases in interest rates. Consequently, debt payments will gradually expand, eventually consuming a significant portion of the nation’s federal spending.

This phenomenon becomes even more apparent when examining official projections for future debt payments. For instance, according to the Office of Management and Budget (OMB), the federal government’s debt service obligations in 2023 are estimated to amount to $660 billion. However, these obligations are projected to increase to $960 billion within a five-year span by 2028. To provide context, it is noteworthy that the OMB also foresees the entire defence budget in 2028 reaching $966 billion.

These projections highlight the precarious trajectory of debt service payments and illustrate the potential strain on federal finances. The increasing magnitude of debt payments relative to other budgetary allocations serves as a cause for concern, signalling the need for prudent management and long-term strategies to address the mounting challenge of debt sustainability.

 

The projections from the Office of Management and Budget (OMB) may appear relatively conservative when compared to the forecasts outlined in a February report from the Congressional Budget Office (CBO). According to the CBO report, interest payments are expected to approach the trillion-dollar mark by 2028 and continue climbing thereafter. In a decade’s time, total interest payments will surpass $1.4 trillion, making it the third largest federal “program” following Social Security and Medicare. Notably, interest payments will exceed defence spending by $300 billion at that point.

On a per-capita basis, the magnitude of these payments should not be taken lightly. For instance, in 2030, the projected $1.4 trillion in interest payments translates to approximately $4,000 per American adult of working age (between 18 and 65 years old). This means that within six years, American taxpayers will be required to contribute over a trillion dollars annually solely to cover long-past federal expenditures related to unsuccessful wars and failed social programs. While the burden may fall primarily on younger workers as the Baby Boomers approach their later years, the fiscal responsibility for the debts incurred by previous generations remains.

However, it is crucial to bear in mind that these projections represent a “best-case scenario.” The estimates from both the CBO and OMB assume a recession-free period in the coming years and relatively stable interest rates. The CBO projects an average interest rate on US federal debt of approximately 2.7 percent in 2023, with a modest increase to 3.2 percent by 2031.

Nevertheless, current trends indicate that the CBO’s optimism may be misplaced. Geopolitical factors point to a potential decrease in demand for the US dollar, which in turn would lead to a decline in demand for US bonds. The United States political and economic isolation, evident through the imposition of sanctions on key global economies, could contribute to higher interest rates. While it is unlikely that the dollar will lose its significance as a global currency, it is expected to face heightened competition, resulting in higher interest rates for federal debt as demand for the dollar diminishes.

Another significant development to consider is the reduced manoeuvrability of the central bank in influencing interest rates compared to a decade ago. Previously, the Federal Reserve could bolster demand and suppress interest rates by purchasing new government debt. However, this approach necessitated significant monetary inflation. Although it appeared effective for a period, price inflation rose to levels not seen in four decades and has remained persistently high. Consequently, the Federal Reserve can no longer simply generate an additional trillion dollars to acquire US government debt, hoping that price inflation remains in check. Political aversion to rising price inflation constrains the extent to which the Federal Reserve can expand monetary interventions to maintain low-interest rates.

Thus, the modest interest rate increases predicted by the CBO may substantially underestimate the true risks at hand.

Furthermore, these assumptions hinge on the assumption that endless increases in debt service will remain politically viable a decade from now. Will voters genuinely accept the notion of enduring increasingly significant cuts to popular government programs solely to meet the demands of bondholders indefinitely? At some juncture, the electorate is likely to declare “enough” regarding escalating debt payments. It is at this point that a country may experience hyperinflation or a sovereign debt crisis. In the interim, the burden of interest payments will only continue to mount.