Soaring Debt Levels: A Looming Crisis for G7 Countries
Analyzing National Debt Using Peder Beck-Friis's Charting Methods
Debt levels among the world's greatest economies have seen a rollercoaster ride throughout history. During crises such as World War I, the Great Depression, and World War II, they skyrocketed, only to eventually plummet during the post-war period.
Fast forward to the current day, and the global financial crisis (GFC) and the COVID-19 pandemic have pushed debt ratios to record highs yet again. Now, G7 government debt teeters perilously close to the peak levels reached at the end of World War II, highlighting the staggering scale of public borrowing.
Rising interest rates have added to the burden of servicing these colossal debts.
G7 government debt (% of GDP)
The USA's Debt Mountain: An Unsustainable Climb
The United States government's debt trajectory has been on the upswing for over a decade now. Projections from the U.S. Congressional Budget Office (CBO) show a steady increase in debt levels, with each new forecast painting an even steeper ascent.
The latest projections suggest that by 2050, U.S. debt could reach nearly 200% of GDP if left unchecked, painting a grim future. Without drastic policy changes, the USA's debt shows no signs of slowing down.
U.S. debt held by the public (% of GDP)
The U.S. Dollar's Iron Grip Remains Unbroken
Despite the mountainous debt burden, the U.S. dollar is likely to retain its position as the world's dominant reserve currency over the next five years.
Its unrivaled usage in global trade and finance, combined with the lack of viable alternatives, buttresses this dominant status. For instance, the dollar accounts for approximately 88% of global foreign exchange transaction volume, reflecting its omnipresent role in international markets and reinforcing its resilience amid fiscal concerns.
U.S. dollar's share of global markets
Interest Payments: The Silent Budget Killer
As debt levels soar, so too do the interest payments. In the USA, these payments have surged dramatically as a share of total federal outlays. Historically, this increase has often triggered fiscal consolidation efforts, as evidenced by the aftermath of World War II and the late 1980s and 1990s.
However, the current debt projections paint a stark picture.
While these numbers are daunting, historical episodes suggest that rising interest costs may eventually compel policymakers to enforce stricter fiscal policies to stabilize debt dynamics.
U.S. government interest payments (% of total outlays)
Debt and the Term Premium: A Tenuous Relationship
It is essential to acknowledge a delicate but discernible association between increases in debt-to-GDP ratios (excluding Federal Reserve holdings) and the U.S. 10-year Treasury term premium - i.e., the additional yield investors demand for holding longer-term bonds.
As government debt rises, the term premium tends to grow, as investors demand more compensation to hold longer-term bonds compared to cash and short-term securities. This dynamic implies that surging public debt could trigger a steeper yield curve, impacting the pricing of fixed income assets.
U.S. 10-year term premium valuation vs. debt
Fine Print
- Note: Past performance is not indicative of future results. Investing in the bond market involves risks, including market, interest rate, issuer, credit, inflation, and liquidity risks. The value of most bonds and bond strategies can change based on changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. The value of bonds may be less than the original cost when redeemed.
- Disclaimer: Statements about financial market trends or portfolio strategies are based on current market conditions. However, they are subject to change without notice. The information provided herein has been obtained from sources deemed reliable but cannot be guaranteed. No part of this material may be reproduced in any manner without written permission.
[1] Federal Reserve Bank of St. Louis. Accessed on May 24, 2022 https://fred.stlouisfed.org/series/GSHOFDG[2] Congressional Budget Office. Accessed on May 24, 2022 https://www.cbo.gov/publication/57241[3] U.S. Department of the Treasury, Monthly Treasury Statement of the Public Debt. Accessed on May 24, 2022 https://www.treasurydirect.gov/вітп/рахунки/журнал-платежів.htm[4] Congressional Budget Office. Accessed on May 24, 2022 https://www.cbo.gov/system/files/118th-congress-2021/reports/57591-2021-05-boards-long-term-outlook.pdf[5] U.S. Department of the Treasury, Monthly Treasury Statement of the Public Debt. Accessed on May 24, 2022 https://www.treasurydirect.gov/ватп/рахунки/журнал-платежів.htm
- With debt levels in G7 countries reaching unprecedented highs, investors might consider the risks associated with government finance and reconsider their personal-finance strategies.
- As the U.S. government debt continues to climb, the interest payments are becoming a significant portion of total federal outlays, warranting careful attention from those in the banking and business sectors.
- The environmental implications of heavy investment in debt infrastructure should also be a consideration for policymakers, as sustainability becomes increasingly important in business and finance agendas.
- While the U.S. dollar maintains its grip on the global financial markets, the delicate relationship between rising debt levels and the term premium could potentially impact the pricing of fixed income assets, calling for prudent banking strategies.
