A major lender to the U.S. government is...the U.S. government, i.e. the Fed. In 2011 the Federal Reserve held $1.7 trillion in government bonds, about one-sixth of the total debt, while today it holds $5.1 trillion, almost a quarter of the total. To put things in perspective, ten years ago the sum of what China and Japan held was 21 percent of the U.S. federal debt, while today their combined share is half of that. There is still one lender that holds a larger proportion of U.S. debt than the Fed—non-governmental domestic lenders. But the Fed has increased its share by 200 percent, while the other domestic lenders have increased theirs by 160 percent.

What this means is that we can expect foreign lenders, who already hold much less U.S. debt than people think, to become a smaller creditor of the U.S. in the future and the Fed to continue to increase its share dramatically. Could we not say the same thing about non-governmental lenders? After all, they have increased their share from 36 to 45 percent of the total. I don’t think so. Unless they are forced to do so by diktat, something that governments do in times of emergency, they will become increasingly wary of the danger of continuing to amass federal bonds. We can expect the bulk of the new lending to come from the Fed, which doesn´t seem to care about the consequences.

This dynamic—monetizing abundant government debt—has been at work for many years now. Much of what we are seeing in the stock market and in the real estate market (where prices are now higher than at the top of the housing bubble in 2006) has to do with interest rate suppression and artificial valuations brought about by it. The various asset-purchase programs have had an impact on interest rates and they, in turn, have influenced (I mean distorted) the larger financial scene, as interest rates, a major economic signal, normally do.

If the U.S. government needs another $112 trillion in the next three decades to cover its fiscal deficits, the options are very few. Since the U.S. finances are already seen as highly fragile by the international community, it is extremely unlikely that foreign lenders will come to the rescue. That leaves the Fed, i.e. money printing, as the only realistic alternative—and perhaps forcing non-governmental lenders to buy part of that debt too.

What a colossal mess.

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Writing at Project Syndicate, Roubini considers how the ocean of red ink being unleashed by the Biden administration and enabled by the Federal Reserve’s pandemic stimulus policies threaten another economic catastrophe.

In April, I warned that today’s extremely loose monetary and fiscal policies, when combined with a number of negative supply shocks, could result in 1970s-style stagflation (high inflation alongside a recession). In fact, the risk today is even bigger than it was then.

After all, debt ratios in advanced economies and most emerging markets were much lower in the 1970s, which is why stagflation has not been associated with debt crises historically. If anything, unexpected inflation in the 1970s wiped out the real value of nominal debts at fixed rates, thus reducing many advanced economies’ public-debt burdens.

Conversely, during the 2007-08 financial crisis, high debt ratios (private and public) caused a severe debt crisis – as housing bubbles burst – but the ensuing recession led to low inflation, if not outright deflation. Owing to the credit crunch, there was a macro shock to aggregate demand, whereas the risks today are on the supply side.

We are thus left with the worst of both the stagflationary 1970s and the 2007-10 period. Debt ratios are much higher than in the 1970s, and a mix of loose economic policies and negative supply shocks threatens to fuel inflation rather than deflation, setting the stage for the mother of stagflationary debt crises over the next few years.

What Makes Today’s Inflation Worse Than the 1970s?

A simple shopping trip is all it takes to find the effects of undesirable inflation these days as the monetary mistakes of the 1970s are repeated. But as Roubini notes, national debts around the world are much higher today, which makes the problem worse. He describes how:

Making matters worse, central banks have effectively lost their independence, because they have been given little choice but to monetize massive fiscal deficits to forestall a debt crisis. With both public and private debts having soared, they are in a debt trap. As inflation rises over the next few years, central banks will face a dilemma. If they start phasing out unconventional policies and raising policy rates to fight inflation, they will risk triggering a massive debt crisis and severe recession; but if they maintain a loose monetary policy, they will risk double-digit inflation – and deep stagflation when the next negative supply shocks emerge.

But even in the second scenario, policymakers would not be able to prevent a debt crisis. While nominal government fixed-rate debt in advanced economies can be partly wiped out by unexpected inflation (as happened in the 1970s), emerging-market debts denominated in foreign currency would not be. Many of these governments would need to default and restructure their debts.

At the same time, private debts in advanced economies would become unsustainable (as they did after the global financial crisis), and their spreads relative to safer government bonds would spike, triggering a chain reaction of defaults. Highly leveraged corporations and their reckless shadow-bank creditors would be the first to fall, soon followed by indebted households and the banks that financed them.

You can see why he earned the “Dr. Doom” nickname! Roubini concludes his piece by observing “this slow-motion train wreck looks unavoidable” and that “the question is not if but when”.

If there’s good news in this, it’s that it’s a slow-motion train wreck. There’s still time to take steps to mitigate the worst of the outcomes if only today’s policymakers would choose to do so. Perhaps the right question to ask is in who’s interest do they serve?

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Here are Visual Capitalist’s Marcus Lu’s and Iman Ghosh’s observations about the U.S. government’s current national debt situation:

The National Debt Today

The COVID-19 pandemic damaged many areas of the global economy, forcing governments to drastically increase their spending. At the same time, many central banks once again reduced interest rates to zero.

This has resulted in a growing snowball of government debt that shows little signs of shrinking, even though the worst of the pandemic is already behind us.

In the U.S., federal debt has reached or surpassed WWII levels. When excluding intragovernmental holdings, it now sits at 104% of GDP—and including those holdings, it sits at 128% of GDP. But while the debt is expected to grow even further, the cost of servicing this debt has actually decreased in recent years.

This is because existing government bonds, which were originally issued at higher rates, are now maturing and being refinanced to take advantage of today’s lower borrowing costs.

The key takeaway from this is that the U.S. national debt will remain manageable for the foreseeable future. Longer term, however, interest expenses are expected to grow significantly—especially if interest rates begin to rise again.

The Risk of Exploding Interest

Lu is absolutely correct regarding the risk of higher interest rates. The accumulation of so much debt at today’s near-zero interest rates threatens to become a time bomb. That’s because the Biden-Harris administration has no plan to reduce it.

Consequently, that large new debt will be rolled over, with new borrowing to pay off Uncle Sam’s old debt bills. Even a small increase in interest rates will explode the amount of interest the U.S. government must pay its creditors.

There are three ways to prevent that outcome:

1. Hold interest rates near the zero percent level indefinitely.
2. Impose new and higher taxes to balance the budget.
3. Reduce government spending to balance the budget.

Holding interest rates near zero percent comes with the cost of much higher inflation. That’s something we’re already seeing today. A Bank of America analyst predicts U.S. inflation will remain elevated for at least the next two to four years.

New and higher taxes come with a large economic cost, harming the U.S. economy’s ability to grow large enough fast enough to make higher interest payments on the debt affordable.

Reducing government spending would be the least painful way to minimize the amount of debt that must be rolled over. As you might imagine, this option is the least popular among politicians and the special interests who fund their election campaigns.

None of this is a surprise to today’s policymakers. They themselves acknowledge the U.S. government’s fiscal policy is on an unsustainable path.

Until they correct course, Americans can expect to swim in an ocean of red ink as far as the eye can see.

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In 2009, in the aftermath of the financial crisis, the debt of the world’s advanced economies shot up the equivalent of a bit more than 10 percent of their GDP; in 2020/21, as a result of efforts to stimulate the economy in the wake of the pandemic, the debt of those same countries increased by the equivalent of almost 19 percent of their GDP. The average national debt for the entire group is now well above the size of their economies.

In many cases, of course, the figures are misleading. This is the case of the U.S., where, if you include the government’s unfunded liabilities, the debt does not amount, as we are told, to some US$28 trillion, but actually to US$100 trillion.

If the economy was growing at a faster rate than the debt in the developed world, that fact would not detract from the enormousness of the problem, but at least we could say that temporarily things were getting slightly less catastrophic. The truth, however, is that it keeps getting worse—and worse. In the world’s developed economies, the debt has multiplied by 4.5 in the last twenty years, while GDP has multiplied by only 1.9.

There was a time when proponents of indebtedness argued that deficits and debt did not matter as long as the economy kept growing. In the end, debt catches up with you one way or another, of course, but that argument has been reduced to utter garbage in the light of the reality of the last twenty years. My guess is that it will look even more ridiculous in years to come since a debt of this magnitude is itself a powerful contributor to slow (or no) growth.

How will this end? There is only one way it can end. If we rule out, (as we should, given the political implications) the kinds of fiscal cuts that taming the debt would entail, we are left with two choices—massive tax hikes and inflation. The size of the debt is such that even in the short run massive tax hikes would not begin to address the problem—not to speak of the real problem, which is that such levels of taxation would cripple any chance of future growth and therefore of addressing the debt. So, we are left with the oldest trick in the book—huge inflation. For centuries governments have resorted to inflation in order to whittle away their debts. Given the lack of realistic alternatives, I see no other way in which this horror story will eventually end, regardless of the fact that, given people’s focus on deleveraging in recent years, consumer price inflation has stayed relatively low. It just a question of time.

What is happening in financial terms is at least as momentous, and perhaps more, than the end of the gold standard in the UK and (partially) the US in the 1930s, the end of the Bretton Woods fixed-exchanged rates at the end of the 1960s and Nixon’s definitive abandonment of the gold standard in the 1970s.

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The next U.S. administration will likely face a global debt crisis that could dwarf what the world experienced in 2008-2009. To prevent the worst, it will need to address the burdensome debt plaguing both the United States and the global economy.

Even before the COVID-19 pandemic paralyzed economies around the world, economists were warning about unsustainable debt in many countries. Take the United States: A surge in spending to mitigate the health and economic impacts of the pandemic has brought the total public debt in the United States to over 100 percent of GDP—its highest level since 1946 and a hurdle that will create a considerable drag on future economic growth. Other types of debt—household, auto, and student loans, as well as credit card debt—have seen similar surges. Almost 20 percent of U.S. corporations have become zombie companies that are unable to generate enough cash flow to service even the interest on their debt, and only survive thanks to continued loans and bailouts.

Multiply that across the globe. Total global debt stands at an unsustainable 320 percent of GDP. Perhaps more worrisome, China is now an important creditor, which adds a geopolitical dimension to the concerns over debt. China is the largest foreign lender not only to the United States, but to many emerging economies. This gives the Chinese political class enormous leverage. Naturally, the combination of strained U.S.-Chinese relations and the dependence of many advanced and developing countries on continued Chinese credit and investment limits the scope for negotiations on debt restructuring or moratoriums.

Worrying About the Debt

If too much debt didn’t concern you before 2020, now is a good time to start worrying. Moyo is absolutely correct in recognizing that having too much debt limits economic growth. She is also right to recognize that China’s debt trap diplomacy will negatively affect the nations whose leaders buy into it.

On the other hand, I think the U.S. government has less to fear from being dominated by China than do smaller nations. In the current fiscal crisis, we’ve seen the Federal Reserve become Uncle Sam’s new sugar daddy, making the U.S. government less dependent on borrowing money from the Chinese than it was in the past. Below is Political Calculations’ latest chart revealing to whom the U.S. government owes money. It shows both a shrinking share of I.O.U.s held by the Chinese and a growing share owned by the Fed:

China has threatened the United States with a “nuclear debt option” strategy of financial warfare. This option involves dumping all its U.S. debt holdings in a fire sale which, in normal times, would hurt the government’s ability to raise funds by borrowing money. But as we’ve learned from the coronavirus pandemic, the Fed could and would step in to fund the U.S. government with as much as it could ever want to borrow.

Knowing the politicians and bureaucrats who run the federal government, that possibility may be a much bigger danger.

The post Is the Presidential Election Winner Ready to Face a Mammoth Debt Crisis? appeared first on The Beacon.

How much worse? In its 2019 outlook, the CBO expected the publicly held portion of the debt would hit 144 percent of GDP in 2049. Now, the CBO predicts the national debt will grow to 195 percent of the nation’s GDP in 2050. Here is a screenshot I snapped of the interactive chart the CBO posted on the main page of its website.

Why is it so much worse? That question is partially answered by another figure from the CBO’s 2020 outlook, showing projected federal spending and tax collections.

The fastest growing part of the budget in the CBO’s projections is net interest on the national debt. Thanks to its growing mountain of debt, the CBO expects these interest payments will soar when interest rates recover.

If you think it can’t get any worse, remember it’s 2020. Of course it can!

For proof, see Mike Shedlock’s chart showing the Penn Wharton Budget Model’s projections of candidate Joe Biden’s budget proposals. This model shows the government collecting more taxes, but also spending much more than under current law, making the U.S. government’s fiscal situation worse.

Meanwhile, the CBO’s current law projections look like what we can expect under a continuation of incumbent President Donald Trump’s policies. Somehow, Donald Trump has become the most fiscally responsible candidate in 2020.

This may be the craziest year ever in U.S. politics.

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The U.S. Federal Reserve recently announced nine new “facilities” (lending programs) and its balance sheet has surpassed the $6 trillion mark. Even the maniacal asset-buying of the post-financial crisis years never took the balance sheet beyond $4.5 trillion. It will go much higher than $6 trillion in the months to come because the Fed is intent on providing dollars, credit and liquidity to just about everyone. That includes numerous central banks with which the United States has swap agreements and a facility called FIMA that lends money to foreign governments in exchange for U.S. Treasuries used as collateral. The aim is to suppress interest rates that were going to rise given that foreign governments were selling U.S. paper in order to obtain much-needed U.S. dollars.

Many people think that the Fed’s unprecedented intervention in the post-financial crisis did not generate inflation because consumer prices did not shoot up. To some extent this is true—in part due to the fact that households avoided going on a spending spree and the fact that the U.S. economy remained reasonably productive while many debtors were trying to deleverage. But monetary interventionism caused major problems, including crazy stock market valuations and an insane amount of corporate debt cheaply incurred with the purpose of buying back stock—at whatever price.

These distortions are now coming home to roost: The stock market lost about a third of its value after the coronavirus crisis started, and the U.S. government is having to bail out corporations that have lost their investment grade because of too much debt (corporate debt now amounts to almost 50 percent of the size of the economy). The severe distortions caused by U.S. monetary policy after the financial crisis mean that a large part of corporate America and other entities, including the financial institutions, are now being bailed out through bottom-up wealth redistribution.

When that happened—on a smaller scale than now—after the financial crisis, the result was enraged populism. I don’t mean healthy, Jeffersonian populism but rather the kind that bends rules and institutions, creates class divisions, redistributes wealth arbitrarily, messes with private property, undermines international trade, and spends colossal amounts of money. In the United States populism took hold of both political parties and much of civil society. Imagine what could happen this time.

Sure, the U.S. government will also bail out households—eventually. After all, household debt, if we count mortgages, student loans, auto loans, credit card loans and other types of credit, amounts to more than $14 trillion. And the Fed has already announced that it will purchase asset-backed securities that will help rescue those types of debts. But for the moment creditors and shareholders, rather than Main Street, are the largest and most direct beneficiaries of monetary policy. The political backlash could be grave.

Not to mention that bailing out debtors by generating more debt can only lead to more problems. Of course, in the type of once-in-a-lifetime crisis we are now experiencing, some form of government intervention to provide liquidity and oxygen to an economy that recently saw 16 million new requests for unemployment benefits is almost inevitable. But it is one thing to do this on a limited scale because economic agents are financially strong, and quite another to do it on the kind of scale we are seeing because almost everyone in America, under heavy incentives from the U.S. government, has been addicted to debt for far too long.

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The Wall Street Journal’s Jon Hilsenrath has summarized it in just three words: Mountains of Debt.

The full impact of the coronavirus pandemic may take years to play out. But one outcome is already clear: Government, businesses and some households will be loaded with mountains of additional debt.

Perhaps the quickest, easiest way to see how much additional debt the federal government, businesses, and households are now accumulating is to look at the changing balance sheet of the U.S. Federal Reserve, which has virtually become over the past month the only creditor to each of these groups. The chart below shows how much the federal government, foreign central banks, and U.S.-based financial institutions and businesses have borrowed from the Fed.

Change in Amount Borrowed from the U.S. Federal Reserve Since February 26, 2020, Through April 8, 2020

That may be the fastest rate at which the U.S. government has borrowed money in its history.

The scariest part is that the chart shows only half of the additional federal borrowing that Congress has already authorized for coronavirus relief. And all this is on top of the $1 trillion deficit the U.S. government was already on course to run in a world free of the coronavirus pandemic.

Hilsenrath explains why today’s rapid and large increase in debt is certain to become a burden on Americans for a very, very long time:

The debt surge is set to shape how governments and the private sector function long after the virus is tamed. Among other things, it could be a weight on the expansion that follows.

Many economists believe low interest rates will help the nation manage the soaring debt load. At the same time, they say high levels of private sector debt could lead to a period of thrift, slowing the recovery if businesses and individuals try to rebuild their savings by holding back on investment and spending.

“People and firms and government are facing a negative shock, and the classic textbook prescription for a temporary shock is to do some borrowing to smooth that out,” says Alan Taylor, an economist and historian at the University of California Davis, who has studied the economic effects of pandemics going back to the Black Death of the 14th century.

Borrowing now amounts to a transfer of economic activity from the future to the present. The payback comes later. “You do have something to worry about in terms of the recovery path,” Mr. Taylor Said.

Today’s debt situation results largely from the steps that state and local governments have taken to try to mitigate the effect of the coronavirus epidemic from spreading in their jurisdictions, many of which have involved ordering the closure of businesses and for residents to stay at home. For many Americans, many of whom live in regions that are far from the areas where the coronavirus’ spread has been most concentrated, the knee-jerk reactions and overly broad restrictions that state and local government officials have imposed are what has put their livelihoods at risk.

For these Americans, it is very rational to want to protect themselves from the impact of government officials abusing their power by repeating the severe actions they have taken in the current crisis. The worse thing they can have is their own personal mountain of debt, so for them, building their savings is the insurance they can count on. Being free of debt means being able to better weather similar crises in the future.

If it weren’t for their existing mountains of debt, businesses now at high risk of bankruptcy, such as airlines, could much more easily afford to shut down a significant portion of their operations for an extended period of time, without any need for a federal bailout.

If it weren’t for its existing mountain of liabilities, the U.S. Postal Service wouldn’t be at such risk of going broke and the quasi-government operation wouldn’t be requesting yet another multi-billion federal bailout.

And if the U.S. government hadn’t already borrowed $23 trillion, much of which was done to fund previous bailouts and other poorly considered schemes, ordinary Americans wouldn’t now be at such risk of having their taxes rise and their freedoms diminished because of the additional burden of the government’s new debt and the desire of too many state and local government officials to fully exercise their powers without restraint.

Had more state and local government officials been more consciously restrained in their actions, matching them to the known spread of coronavirus infections within their jurisdictions, the cost of the coronavirus pandemic for ordinary Americans could have been much less.

Alas, that’s not an objective that many of America’s current politicians and bureaucrats have sought to achieve.

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