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by peruvian_bull
The Monetary Event Horizon
Now, with the debt limit suspended, the Treasury is freed from the fetters of supposed fiscal constraint and can borrow without abandon.
Welcome to the Event Horizon.
A little over a month ago, deja vu struck Congress as they underwent their ritual debt ceiling brinkmanship. This time, the players fought over what concessions could be made as the U.S. approached the deadline of $31.4T in total debt outstanding while Yellen warned of severe austerity measures that the Treasury would have to undertake in order to avoid default.
As usual, the game was played with the typical jawboning and accusatory statements so often held by our politicians- but the conclusion was one we had not seen before. On Saturday, June 3rd, President Joe Biden signed an agreement that lifted the debt ceiling completely for two years, and eliminated spending caps after 2025, allowing unlimited government spending.
The debt limit issue would be revisited in 2025.
On the Treasury’s own reports, they list the statutory debt limit as 0. I guess they didn’t have enough room to put “Infinity” down.
From its very inception, the United States has had a national debt. During the American Revolutionary War, the country accumulated a debt of $75 million by borrowing from domestic investors and the French Government to fund the purchase of war materials. Over the course of the following 45 years, the debt steadily increased. However, in 1835, there was a significant reduction in the debt due to the sale of federally-owned lands and reductions in the federal budget.
Soon after that, an economic depression emerged, leading to a significant increase in the national debt, reaching millions of dollars. During the American Civil War, the debt skyrocketed by more than 4,000%. It surged from $65 million in 1860 to $1 billion in 1863 and eventually reached around $2.7 billion shortly after the war concluded in 1865. Throughout the 20th century, the debt continued to grow steadily. By the time the United States financed its participation in World War I, the debt had reached approximately $22 billion. After WWII, the national debt hit a cycle high and was slowly offlaid via spending cuts, financial repression, and inflation, decreasing until it hit a low of 30% debt to GDP in 1982.
The Afghanistan and Iraq Wars, the 2008 Great Recession, and the COVID-19 pandemic have all accelerated the growth of the national debt. From fiscal year 2019 to fiscal year 2021, spending witnessed a substantial increase of approximately 50%, mainly attributable to the effects of the COVID-19 pandemic. Factors contributing to sharp rises in the national debt include tax cuts, stimulus programs, increased government spending, and reduced tax revenue resulting from widespread unemployment.
Now, the debt level is increasing faster. And this time, it’s occurring without a crisis to spur massive government borrowing.
This removal of even the faintest whiff of fiscal constraint has truly allowed the Treasury to plunge deeper into the debt black hole- in a shocking turn of events, the national debt has increased by over $1.1 TRILLION in 41 days!
It now stands at a staggering $32.51 Trillion- a rate of $27B a DAY.
This was funded by a mix of Treasury notes, bills, and bonds, and a small amount of something called FRNs- floating rate notes.
This recent tsunami of new Treasury issuances could be indicative that the United States is entering what is called a debt spiral.
A debt spiral occurs when an entity, such as a person, business or country finds itself needing to borrow money in order to fulfill its existing financial obligations.
This can happen, for example, when you take out a payday loan to cover your car finance payment or when you rely on loans to pay off your credit cards. Debt spirals are incredibly challenging to break free from because each time you borrow money, you accumulate additional interest on top of the amount you already owe.
When you are caught in a debt spiral, the primary focus is on servicing your debt rather than making progress in paying it off. As a result, debt remains stagnant or continues to grow. This situation creates a constant feeling of financial instability, where you are constantly teetering on the edge. With no extra cash available, every time you need to make a purchase, you are likely to accumulate even more debt.
This is what the United States is entering. At $32T of Federal debt, that means if rates stay at 5% the U.S. will eventually have to pay $1.6T a year in interest alone to service the debt. That doesn’t even include principal payments.
I made this graphic to visualize the process.
For example, let’s take a look at just the shortest-term debt securities that are maturing this month. Per the Treasury’s monthly report, around $1.17T in bills will mature in July. All of this debt was recently issued and thus the rate step change won’t be too severe, but will still have to be refinanced at current rates.
In terms of notes, approximately $183B will have to be refinanced as these instruments mature.
The amount of TIPs maturing is almost immaterial at $53B. Similar with Floating Rate Notes, of which $82B mature this month.
As these debt securities mature, the Treasury pays them off by issuing new ones, “rolling the debt” forward similar to how options or future traders roll contracts week to week or month to month.
The issue is, all these securities are refinanced at higher rates and thus cause more interest expense to incur across the balance sheet. This is fueling a massive rise in interest expense paid by the United States.
As the interest rate rises, the amount of debt issued must rise in tandem. Which means the total interest paid rises even more, and thus more debt, in a devastating feedback loop. What worsens the situation is that this process is non-linear, not only logically from the compounding interest, but from other feedback loops as well.
In June, the interest expense paid for the last twelve months hit $852B- a 28% compounded annual growth rate.
If this keeps growing at this rate, we will be paying $1.78T in interest alone in 2025.
And $2.28T in 2026.
The problem the central planners face is that of a true dilemma. If they raise rates to fight inflation, they’re only accelerating the debt spiral.
However, if they lower rates and begin QE, this will in time cause more inflation, which will by default increase Treasury expenditures as the prices of labor, infrastructure, healthcare and military equipment rises.
Which will increase the amount of debt the Treasury must issue. Which will push us further into the debt spiral. I have termed this the Peruvian Bull Debt Paradox. The higher they raise rates, the closer and larger the next QE tsunami will become.
The U.S. is already paying record amounts in interest expense- and the Fed hasn't even finished its hiking cycle. What happens if "higher for longer" proves to be true, and more of the $32T debt load gets refinanced at 5%??
The US paid $122B on interest alone in June of 2023. That's 18% of all Federal outlays for the month.
The markets are sniffing this out. Last week, the 10-year Treasury broke 4%, a key resistance level seen in February 2023 before the bank failures of SVB and FRB, and September 2007. And the 2yr hit a high not seen since before the 2008 financial crisis.
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