Servicing the Debt

The US Debt Clock notes that the current expense of servicing the federal government debt of US$ 21.2 trillion is $303 billion. This means that the Treasury has been paying interest of “only” about 1.4% on the debt. The amount of money that the Treasury will be paying out in interest on the debt is going to increase markedly very soon. It could easily double.

One reason for this is that the Fed has raised the base interest rate to 1.75% to 2.00% recently and is slated to raise rates even more in the near future so that one can expect that the base rate will be up at 2.5% by the end of 2018 with two more hikes highly probable in 2019 so that 3.0% will be the going rate by the end of June 2019.

If an inversion of the yield curve results, which is likely, then history suggests that a recession will follow soon afterwards. Given that the Fed is also intent on reducing its balance sheet with the consequence that tighter credit will be the result, it is reasonable to ask how this is going to affect the amount of interest that the Treasury will have to be paying on the debt.

The current annual federal deficit is hovering at $781B, and the CBO sees higher deficits in the future and consequently a heavier debt load that will have to be financed. Reckoning that the present recovery is now the second longest one in history and that the Fed in its infinite wisdom is intent on doing its best to bring on a recession, it can only be expected that deficits will accordingly increase due to diminished tax income for the government.

In this context the Trump trade war could be seen as an attempt to bring about inflation with the purpose of reducing the real weight of the debt before a catastrophic situation comes about. Tariffs on imports will have an immediate effect on the prices of goods in the consumer markets, and that will probably set off a wage-price spiral that will be to the advantage of the Treasury. This policy depends on workers getting higher wages to offset the price inflation brought about by the trade war. Otherwise the pain inflicted on workers will be severe.

There is much at stake here. The Sino-Russian war on the US dollar is also in play as the renminbi has recently gone down against the greenback. Forex traders who are long the US dollar may enjoy the ride until inflation takes its toll while the bear bond market roars full-steam ahead.

Walter Snyder

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