Saturday, 27 February 2016 00:00

Federal Debt And $1 Trillion In Debt Servicing

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Point of Discussion – The United States Government is Potentially in an Inescapable Debt Trap

Since the great financial crisis of 2008-09, the private sector and the household sector have deleverage (or moderately leveraged) while the government sector has leveraged significantly. To put things into perspective, the total Federal debt was $9.2 trillion at the beginning of 2008 and Federal debt has doubled to $18.2 trillion by the third quarter of 2015.

While the government was forced to leverage in order to avert a bigger financial disaster, continued leveraging by the government sector can potentially put the United States in an inescapable debt trap and result in crowing out effect for the private sector.

With the Congressional Budget Office releasing budget estimates for the period 2016-26, the Federal debt will continue to surge according to estimates and this is a point of concern. The chart below shows the annual deficit for the government for the period 2016-206 and during this period; the government is likely to pile on another $9.9 trillion in debt.

For the third quarter of 2015, the Federal debt was $18.1 trillion and considering the same level of debt for the beginning of 2016, the debt at the end of 2026 is likely to be $28 trillion.

 

Budget Deficits For The United States (2016-2026)

US Budget Deficit Projections 20016 to 2026

 

The biggest concern in my opinion is that with rising debt, the debt servicing cost will swell and according to budget estimates, the net interest cost will be $830 million by 2026 (gross interest of $1.0 trillion).

However, if interest rates rise faster than expected, the gross interest cost is likely to be well above $1 trillion. I fear a scenario where the government has to pile on debt just to service the existing debt.

 

Interest On Treasury Debt For Period 2016 to 2026

Interest On Treasury Debt 2016 to 2026

Another important point to note here is that the CBO expects real GDP growth of 2.5% for 2016, 2.6% for 2017 and 2% for the period 2018-2026. I don’t expect GDP growth to be smooth in the next 10 years.

There can be years with decent GDP growth, years with very sluggish GDP growth and potentially quarters or years in recession. Therefore, the deficit estimates can be revised upwards and it would not be surprising if the total Federal debt exceeds $30 trillion by 2026.

From an investment perspective, the swelling debt is a key reason to be bullish on gold and to believe that the bull market for gold still has legs. Also, as Federal debt increases and there is an increase in debt monetization, Treasuries will be less attractive from a long-term investment view. For now, it seems that the US government is slowly, but surely heading into an inescapable debt trap.

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