All Else Is Not Equal

 Read: https://www.zerohedge.com/markets/deficit-surge-will-lead-lower-rates-not-higher

If all else were equal, then more debt would require higher interest rates. Many “bond bears” suggest that rates must rise as deficits increase and more debt is issued. The theory is that at some point, buyers will require a higher yield to buy more debt from the U.S. Such is perfectly logical in a normally functioning bond market where the only players are the individual and institutional bond market players.  In other words, as long as “all else is equal,” rates should rise in such an environment.

However, All Else Is Not Equal.  What will happen is the Fed will kill the economy by continually raising rates, this will cause a recession and then the Fed will engage in a massive QE bond-buying program of $4 trillion or more to lower the rates.  The Fed has the power to raise rates and lower rates as it has demonstrated and they don't want to kill the golden goose / magical money tree.  So they will lower rates.  And it will end in a frozen wasteland of an enormous amount of unproductive government debt at close to zero interest rates, just like Japan. Given the current push by Central Banks globally to suppress interest rates to keep nascent economic growth going, an eventual zero-yield on U.S. debt is not unrealistic.

Deficit of $222 Billion in July 2023

 The deficit in July 2023 was $222 billion, CBO estimates—$11 billion larger than the amount recorded in July 2022. The federal budget deficit was $1.6 trillion [actually $1.617 trillion] in the first 10 months of fiscal year 2023, the Congressional Budget Office estimates—more than twice the shortfall recorded during the same period last year. Revenues were 10 percent lower and outlays were 10 percent higher from October through July than they were during the same period in fiscal year 2022.  https://www.cbo.gov/publication/59377/html

Why were the outlays higher?  Mostly because of these 5 categories:  1) Social Security benefits rose by $111 billion (or 11 percent); 2) Medicare outlays increased by $104 billion (or 18 percent) ; 3) Medicaid outlays increased by $29 billion (or 6 percent); 4)  Net outlays for interest on the public debt rose by $146 billion (or 34 percent), mainly because interest rates are significantly higher than they were in the first 10 months of fiscal year 2022; 5) Outlays of the Department of Education increased by $91 billion (or 57 percent), primarily because in July the Administration recorded the costs ($71 billion) it estimated for modifying outstanding student loans.

What was the net interest for the month? It is $572 billion FYTD, and last month this was at $505 billion, so the interest for the month was $67 billion.  Defense spending FTYD is $630 billion and last month this was at $576 billion.  So it was only $54 billion for the month. (This doesn't seem right, usually military spending is about $65 billion per month, so maybe there is a mistake somewhere.)  But if this is a sporting event, team Interest won July over Defense.  Time for Defense to spend more.

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On 7/31/2023, the total national debt was $32.61 trillion.  One year earlier, on 7/31/22, it was $30.6 trillion.  So it increased 6.5% in one year.

Interest on Reserves

 The Federal Reserve pays interest on reserve balances.  It started doing this in October 2008 as part of the reforms after the Great Recession.  However, I think this is very problematic.  The total reserves as of 8/2/23 are $3.19 trillion.  The rate paid is about 5.25%, or about $175 billion per year.

This money actually fuels inflation.  When the Fed raises rates, this amount goes up.  The banks love it because it is free money - it is effectively a subsidy from the Fed.  They don't have to make risky loans to earn it.  And the bizarre thing is that the Fed doesn't treat the amount paid as an expense.  Instead it is capitalized.  The total is called a "deferred asset" because of the fiction that this reduces what the Fed owes the US treasury in the future..  The total as of 8/2/23 is $85 billion.  This total is going to keep going up.  This is still a very small part (about 1%) of the Fed balance sheet, which is $8.2 trillion.  It is "magic money" that just falls out of the sky, that one party sees as free money and the other party doesn't treat as an expense.

Here is an article on the topic: https://www.cato.org/cato-journal/spring/summer-2019/interest-reserves-history-rationale-complications-risks#complications-and-risks  One must question the wisdom of making IOER a permanent part of the Fed’s toolkit, given the resulting complications and risks.

New Deficit Projection

 

Here is my latest deficit projection.  The long term forecasts from the CBO use percentages of GDP, so I included more columns showing receipts and expenditures as a percent of GDP.  Also, I rounded numbers to the nearest $50 billion (anything smaller is a rounding error).  This shows the 150% mark exceeded in 2039, which is 4 years sooner than last years forecast, so this is a significant deterioration.  The good news is that the GDP projections are higher (because of inflation).  The bad news is that expenditures separate from interest are much higher (also because of inflation).  And of course the interest amounts paid are much higher.

What do I think will happen in 2039?  Well we can't know the year exactly, but at some point the entire dollar based system will veer off into hyperinflation, and it will have to be replaced with something else.  So I don't see how our system can continue past 2039.  And that is a relatively optimistic forecast.  It is showing that interest rates in 2039 will only be 4.5% and they are already higher than that.  So I expect the next forecast to be even earlier than 2039.  Another thing is that Social Security will run out of money in 2034, and I expect it to remain fully funded, so this will add to the primary deficit, and that is not accounted for here.

Don't question the ability of the US to pay its debts

Two months after the U.S. neared its first-ever debt default, President Joe Biden has created a team to assess ways to avert future standoffs over the country's debt ceiling, according to a media report Thursday.

The working group, consisting of administration officials and without any Republican members, will be led by White House Counsel Stuart Delery and National Economic Council Director Lael Brainard, Bloomberg reported, citing a White House statement.

“Now that the latest debt ceiling crisis is behind us, it is necessary to explore all legal and policy options to prevent Congress from ever again holding hostage the full faith and credit of the United States,” the statement said.

https://seekingalpha.com/news/3989480-biden-said-to-form-team-to-avert-future-debt-limit-standoffs

Because the debt limit should be infinity, right?

GDP is now $26.8 Trillion

 Current‑dollar GDP increased 4.7 percent at an annual rate, or $305.2 billion, in the second quarter to a level of $26.84 trillion.  https://www.bea.gov/news/2023/gross-domestic-product-second-quarter-2023-advance-estimate

The Debt Held by the Public is $25.7 trillion as of 7/31/2023.  Thus, the debt to GDP ratio is currently 95.8%.  So nothing to worry about.  The last time I calculated this, only 3 months ago, the ratio was 92.9%.

I think as long as this ratio stays below 101% (100% plus a margin for error) then we can continue business as usual.  Once it gets to 101% then the interest as a percent of GDP will be greater than the interest rate and it will start compounding more rapidly.  This should occur sometime in 2025, probably.

Update (October 24): 

The BEA made another estimate of 2nd Quarter 2023 GDP: 

Current dollar GDP increased 3.8 percent at an annual rate, or $249.4 billion, in the second quarter to a level of $27.06 trillion.

So they said that GDP didn't increase as much as they thought before, but the current level is higher.  This is because they also adjusted the 1st quarter higher. Anyways, this is good news.

The debt to the public is now at $26.5 trillion so the ratio is now only 97.9%, which is still less than 100%.