Why the US economy is ringing alarm bells - Kahawatungu

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What with a 250th birthday, Taylor Swift’s wedding and the football World Cup, Americans could be forgiven for taking their eye off the ball this summer. But signs of economic trouble have been building. This week they hit the headlines when US national debt passed the $40tn mark, raising concerns both at home and abroad.

How did the we get here?

It took almost 200 years for America’s national debt reach $1tn for the first time, says Maya MacGuineas, president of the Committee for a Responsible Federal Budget.

That milestone back in 1981 was treated as a wake-up call. “At that time, President [Ronald] Reagan told the nation in a televised address, ‘If we as a nation needed a warning, let that be it’,” she said.

“Jumping to America’s 250th year, we are spending more than that just on interest payments on our debt.”

Hitting the $40tn milestone was expected – driven by public spending surges under both the Donald Trump and Joe Biden administrations – but it marks another line in the sand.

Ballooning costs for social programs and other spending have outstripped revenues undermined by tax cuts. Responses to crises such as the 2008 financial crisis and the Covid pandemic have led to increased borrowing.

Add to that higher interest rates in response to recent inflation shocks and the picture begins to look grim.

How bad is it?

At the beginning of Trump’s first presidential term in 2016, US national debt stood at just under $20tn. It has doubled in the decade since.

According to the Congress Joint Economic Committee, the figure is rising by about $90,000 every second, or $7.8bn a day.

“What’s very different now compared to a decade ago is the level of interest rates,” says Eric Swanson, professor of economics at University of California and former senior economist at the Federal Reserve.

“Long-term interest rates in the US are at multi-decade highs – part of that is concerns about inflation, but part of that is concerns about the extreme levels of US government borrowing.”

The bond market is demanding higher returns with investors wary of the scale of the US’s debt, but also because tech firms borrowing eye-watering sums to spend on AI are competing with the government for investors’ cash.

“What happens when interest rates go up is that the funding of the deficit becomes more expensive,” says economist Mohamed A. El-Erian, a professor at the Wharton School.

Interest payments on government debt are now 15% higher than the same period last year, says El-Erian. They are almost 20% of tax revenue “larger than defence”, he adds.

Should I be worried?

The US is nearing its $41.1tn debt ceiling, with debt forecast to climb to about $64tn by 2036, according to the Congressional Budget Office.

But the situation is not yet critical, say economists. The US’s position as the world’s largest economy and the dollar being the world’s reserve currency gives the US a “much longer runway to fiscally misbehave” than other countries, El-Erian says.

“We’re getting to a point where it’s a flashing yellow light. It’s not a flashing red light,” he says.

Swanson says other countries have had similar, or higher debt levels.

While US national debt is 126% compared with the size of the economy, it’s lower than other G7 nations Japan and Italy.

But investor appetite in lending the US government money through buying bonds is “diminishing”, Swanson warns, creating a “vicious” cycle, requiring the government to offer ever higher returns to keep investors purchasing its debt.

And higher US borrowing costs inevitably spill over, raising other countries’ borrowing costs too. “What happens in the US never stays in the US,” says El-Erian.

What does it mean for you?

Households will likely face higher rates for mortgages, auto loans and credit cards as a result of the current situation, with those on lower incomes hit hardest, El-Erian says.

There’s also a secondary effect on consumers as higher borrowing costs for firms is often passed through to them via higher prices.

So the impact of the debt “finds its way to the pocketbooks of people one way or another,” says MacGuineas.

What next?

The US’s latest figures show the economy slowed in recent months, but it is still growing at fair lick.

That matters because economic growth means more tax revenue, which can pay for spending, whether that’s on government programmes or interest payments. With enough growth, the debt problem is eased, points out El-Erian.

But without sufficient growth the US might have to look at other options. They could include reforming the tax system and public spending, or austerity. Debt restructuring is another option.

The strategy so far employed has been a kind of financial engineering, with the Treasury department on Wednesday stepping in to buy back government debt, boosting demand for bonds and lowering borrowing rates.

But the impact was shortlived with long-term borrowing costs bouncing back up a day later.

With the mid-term elections approaching, the White House will want to be seen to be delivering on the economy. Affordability is the top concern among voters. But the other options are no more appealing and El-Erian is doubtful the government is ready to look at other measures.

“I don’t see anything happening that is going to significantly lower the deficit over the next two to three years. If you look at the political talk, it’s about tax cuts.”

By BBC News

Reporting originally appeared via Kahawa Tungu. Read the full source for additional context.