Earlier this year, a report from the Congressional Budget Office offered a torrent of serious warnings about the future of America’s economy. Next year, the leading lights will go to the combination of inflation and recession, which have been in the books for most of 2022. And yet, in less than ten years, a new start may be about to steal the top billing: interest payments on the national debt.
Why? Because as it stands, the Federal Government can expect to start paying up to three times as much in interest as it is doing now. In fact, interest payments may become the “largest program” in the Federal Budget, surpassing Social Security or Medicare funding.
What Is Causing High Interest Rates?
By 2032, the amount of money required to pay the interest on the national debt – not the debt itself – will have reached a historical height. To explain the causes of this unfortunate record, the Peter G. Peterson Foundation pointed to three main factors.
Already blamed for the cost of living crisis and the measures that will trigger the next “Great Recession,” the effects of inflation are great and far-reaching. As the national currency loses its purchasing power, banks and bondholders risk losing the earnings from their initial investment.
When inflation is high, the money you get back from a government bond may not buy as much as it did ten years ago. To compensate for this risk, banks simply raise their total interest rates. Earlier in 2022, the Federal Reserve had already been forced to raise its interest rate cap, as the current inflation levels were making it unsustainable.
Increased government spending
The latest round of government programs and “post-Covid reconstruction” investments were necessary to kickstart a heavily hurt economy. However, many of these one-time bonuses and aids had to be repeated two to three times. Meanwhile, many government offices launched new long-term projects, whether through tax cuts, subsidies, or direct aid.
Government spending has been on the rise over the past two decades. However, the past two years have seen a steeper increase, which now threatens to overcome any increases in our Gross Domestic Product. Immediately following the pandemic, government spending pushed our debt-to-GDP ratio above 100%.
With recession looming on the horizon, this ratio is expected to increase, and it will be harder for the Treasury to keep up with debt payments.
Raising the federal debt ceiling
Although traditionally a non-issue, the Federal Debt ceiling is now a regular feature in early-year economic debates. Why? Partly because it offers the minority party an opportunity to negotiate with a ticking clock looming over Congress’ head. But the main reason why the debt ceiling is now a touchy subject is that it continues to increase.
The debt ceiling is the maximum amount of money the Federal Government can borrow. The problem with the debt ceiling is that it affects a budget that has already been approved and spent. If no agreement is reached, it can cause the Government to delay or default on its payments. According to analysts, early 2023 will likely bring renewed clashes between Democrats and Republicans over the debt ceiling.
How do creditors deal with increased risk? By increasing their interest rates!
Why Is This Bad?
Interest payments appease creditors, but they do not yield any significant benefit for the country or the population at large. Oversized interest payments are a major financial burden, but just like paying the “minimum payment” on a credit card, they do not tackle the overall outstanding debt.
And yet, these interests must be paid, lest the country loses its credit rating – which could, in turn, trigger a financial panic. So where will this money come from? It will require a careful balancing act and deep cuts into education, healthcare, defense, or renewing critical infrastructure.
The money we spend today is the legacy we will leave for the country’s future generations. As it stands, the Peter G. Peterson Foundation warns, “Interest costs would exceed what the federal government has historically spent on key investments.” Will this be the inheritance we leave for our children?
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