by Zain Jaffer
A Wharton School / University of Pennsylvania budget model predicts that the global financial markets can no longer function properly if the US debt deficit continues on its present course of growth for the next twenty years. Key to this is the fact that US debt, in the form of short term bills and long term ten, twenty, and thirty year bonds, are globally held as fixed income instruments.
Unfortunately the attitude in the US Congress, despite the attempts of many politicians to balance the budget, is to kick the can down the road to future elected officials. Some even believe that Modern Monetary Policy (MMP), the belief that the government can simply run its currency printing press as much as it wants, is valid.
According to the study, “forward-looking financial markets are, therefore, effectively betting that future fiscal policy will provide substantial corrective measures ahead of time. If financial markets started to believe otherwise, debt dynamics would “unravel” and become unsustainable much sooner.” Actually this is already partially true as the BRICS countries are already shedding much of their holdings of US treasuries. So many of the current buyers now are foreign allies, corporate treasuries, banks, but much of it was bought by the Fed during the periods it did Quantitative Easing (QE).
The US debt clock states that the current US Debt to GDP ratio as of mid-November 2023 was almost 125%, at a total debt of $33.7T. In 1960, that ratio was around 52.2%, and as late as 2000 was around 55.5%. The current debt is loaded with entitlements such as Social Security and Medicare, and defense spending. But increasingly the largest part of the debt are the interest payments on the debt itself, the yields promised to treasury bill and bond holders.
Wharton/UPenn believes that the US cannot exceed a 200 percent ratio of Debt to GDP even under favorable market conditions. In its study, they do not include the $6.8T that the US owes itself and use a figure of $26.3T for their calculations. It also said that larger Debt to GDP ratios in countries like Japan, are not relevant because those countries have a much larger household saving rate. US consumers on the other hand prefer to buy on credit instead of cash, while other countries only purchase what they can afford.
The study said that after twenty years of no policy changes, any future tax increases or spending cuts would no longer prevent a debt default. Unlike technical defaults where payments are merely delayed, this default would be much larger and would truly shake up the global economy.
The twenty-year timeframe is the “best case” scenario for the United States, if global markets believe that the US will truly change its course. If however countries start to lose faith en masse that the US can truly pay back its huge debt, then as the attitude of the BRICS has shown, the US will then lose the status and prestige it has and be replaced by other alternatives.
Think of someone who has been running a long unpaid bar tab, and still wants to order meal and drinks. At some point, even if the bar owner is a friend, the customer will be asked to settle the running total first before being allowed to order more.
Personally as an immigrant who was raised in a family that was careful about spending only what we had saved, and avoiding the excessive use of credit, it is time for Americans to learn how to tighten their belts and not carry that attitude with them when they get elected into office and spend taxpayer dollars they have not collected yet.
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