The US government’s debt is already outperforming the country’s economic output. Huge other issues are still pending. Can that come well?
—
–Extensive stimulus program launched: US President Joe Biden.
Foto: Evan Vucci (AP)
The new US administration under Joe Biden shows no reluctance when it comes to government spending. After an already decided Covid-19 emergency package worth 1.9 trillion dollars (advertised 1,900,000,000,000 dollars), further expenditures amounting to 6 trillion are due over the next decade.
How and for how long can Americans afford it? The answers:
The development of the debt ratio
In order to be able to classify national debt, one has to put it in relation to a country’s economic power, to the gross domestic product. This rate has risen sharply in the US since the 1980s, but never to the same extent as last year. In addition to high spending under Donald Trump, this is also due to the slump in the US economy in the previous year.
According to the assessment of the impartial budget office of the US Parliament, US debt will double from currently 100 to 200 percent of gross domestic product by the middle of the century.
The limits of debt
How much debt a country can afford depends on economic growth, interest rates and inflation. If interest rates stay lower than the economic growth rate, debt hurts less. When a person’s wages rise faster than the interest on their debts, those debts also become less and less of an issue.
But if the interest rate rises and outperforms growth, the higher the debt, the worse the consequences. And usually the interest rate is not independent of the debt. The higher the latter rises, the greater the risk for creditors of not getting the money back. Accordingly, they will ask for a higher interest rate.
–Main protagonist of US spending programs: Joe Biden’s Treasury Secretary and ex-Federal Reserve chief Janet Yellen.
Photo: Dake Kang (AP, Keystone)
They will do the same if there is a threat of rising inflation, because that too reduces the purchasing power of the money borrowed. However, not all countries are equally exposed to these dangers.
The “exorbitant privilege” of the USA
Countries with their own central bank and a strong currency have a great advantage. You are indebted in your own currency and can, if necessary, print the money owed yourself. For this reason alone, they pay much less interest on their debts.
One of these lucky countries is Switzerland, which also has a comparatively low debt ratio of only 45 percent.
The whole world is investing in dollars and in US government debt because they are considered particularly safe. A national bankruptcy of the USA is therefore as good as impossible.
Safe and strong currencies are those that are of great importance in international payment transactions and for maintaining reserves. No currency is anywhere near as great a weight as the US dollar. On the one hand, this has historical reasons, but it is also due to the dominance of the US capital market.
The whole world is investing in dollars and in US government debt because they are considered particularly safe. A national bankruptcy of the USA is therefore as good as impossible.
Risk of inflation and the US Federal Reserve
The greatest economic The risk of a sharp rise in debt for the USA is high inflation. A sharp increase in government spending can overheat the economy and trigger a spiral of price increases.
If that happens, the US Federal Reserve will have to raise its key interest rate significantly in order to put the brakes on the economy again. The government would then have to pay more for the debt and also put the brakes on spending because of inflation.
How great is this danger? In May, US inflation rose to 5 percent, the highest it has been in 13 years. But in the capital markets this is seen as a temporary development. Long-term interest rates have recently fallen again and remain at an all-time low at 1.46 percent for 10-year government bonds. The US Federal Reserve has so far also shown no interest in changing its extremely expansionary monetary policy.
Consequences for the world
The risks of excessive US debt are not limited to the US. Rising inflation and a sharp rise in interest rates in the USA would severely affect the capital markets worldwide. Interest rates would rise anywhere. Currency turbulence would be just as likely as debt crises, especially in emerging markets.
Found a bug? Report it now.
–
