New threshold: CBO director Phillip Swagel testifies during a Senate Budget Committee hearing in Washington. It is his non-partisan office that predicts that the government’s net interest payments will reach 3% of GDP by 2028. — AP
IN five years’ time, the US government’s annual interest bill on its debt is projected to reach US$1 trillion, or 3% of gross domestic product (GDP).
Is this an impending financial catastrophe, as the first figure might imply, or a manageable burden, as the second one indicates?
US debt sustainability is back in the spotlight after Fitch downgraded the US credit rating this month.
High interest rates and bond yields are increasing the amount Washington must pay to service the federal debt, which neither economic growth nor inflation look like sufficiently eroding.
Managing the ballooning debt is more challenging now than when S&P stripped the United States of its AAA rating in 2011.
The deficit before interest payments was lower then, economic growth was weak but still higher than prevailing interest rates, and the Federal Reserve (Fed) was buying boatloads of bonds. Conditions are far less benign now.
But as ever, the crux of the matter is the price at which investors will lend to Uncle Sam, not whether the debt will be serviced.
On that score, history suggests their appetite for dollars and dollar assets will hold up well.
Doubts over the US financial trajectory and the dollar’s relative value or status as the world’s preeminent reserve currency are nothing new.
Consider this Business Week article from March 1978: “The role of the dollar as the world’s major reserve currency is beginning to be eroded by its weakness and the inability of the Carter Administration to check its fall. Investors are hurrying to move cash into marks, Swiss francs and Japanese yen. Foreign central banks are doing the same.”
The US currency has gone through many peaks and troughs since then, experiencing significant bouts of official intervention and dollar buying and selling along the way.
In relative terms, it has more than stood its ground.
On a broad real effective exchange rate (REER) basis, the dollar today is around 12% higher than its 50-year average going back to 1973, according to Exante Data.
Exante Data noted that the dollar is in the 88th percentile relative to its history over the past half-century, meaning it has only been weaker 12% of the time since 1973.
In the last 30 years, the dollar’s real effective exchange rate has appreciated around 20%, making it by far the best-performing of the Group of Four currencies over that period.
The dollar is the number one destination for global savings and investment flows, and there is little evidence that its preeminent status is under threat. Investors want to hold the world’s reserve currency and be in the world’s deepest, most liquid capital markets.
“People are locked into these markets. What else are they going to buy? Dollar assets are the only game in town,” said Chris Marsh, senior adviser to Exante Data.
There is still no viable alternative. Germany’s 1.6 trillion euro bond market is a fraction of the US$23 trillion treasury market, Japan’s central bank and domestic investors own almost all Japanese government bonds and the political risks and capital controls in China are significant.
Even if the dollar were to fall 15% to 20% over a few years, would that be cause for panic?
That said, America’s deteriorating fiscal health means there is less room for complacency than ever before. Interest payments as a share of federal revenue, spending and the economy are set to reach historically high levels early in the next decade.
Fitch sees gross government interest payments as a share of revenue rising to 10% in 2025 from 7% last year, and the non-partisan Congressional Budget Office (CBO) predicts net interest payments will reach 3% of GDP by 2028, a new post-1940s high of 3.2% of GDP a couple of years later, and 6% of GDP by the midway point in the century. — Reuters
Jamie McGeever is a Reuters columnist. The views expressed here are the writer’s own.
