Briar H. from Spokane, WA asks: Hi Mitch, I saw an article recently about the $2 trillion interest bill hitting governments around the world. I have a hard time squaring how so much debt around the world could be a good thing. It feels like a financial crisis waiting to happen. Would love to hear your thoughts. Thank you.
Mitch’s Response:
Thanks for writing. I’m aware of the data point you mention in your question – according to an analysis by the International Monetary Fund, governments are expected to spend a net $2 trillion in interest on debt this year, which is 10% higher than last year. Higher interest rates are largely to blame, but governments have also been spending more.1
According to one analysis, net interest on global government debt could top $3 trillion by 2027. That’s only four years away.
To break down the figure a little more, the United States accounts for about one-third of all the net interest payments due on debt, but we also have the largest economy in the world – by far. I’ve written recently about the U.S.’s debt, deficits, and interest payments, so I won’t rehash that here. I’ll focus my comments on global debt, per your question.
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I think it’s important to affirm one of the points you make in your question, which is that ever-increasing debt and interest costs are not a positive for many countries. The more a government has to spend on interest costs, the less they have to spend on more productive means, like research and development or investment. Governments with rising interest costs will either need to cut spending, raise taxes, or keep running deficits, which only adds to interest costs given the current interest rate environment.
The upshot is that the market will often signal when a country’s fiscal situation is problematic. When the UK and Italy proposed cutting taxes earlier in the year, for instance, bond markets reacted quite adversely – which caused the governments to reverse course. In the U.S., spending more and more on interest costs means other forms of spending get “crowded out,” which historically has resulted in a greater appetite for fiscal tightening. Ongoing congressional gridlock and an upcoming presidential election may not make deficit reduction legislation likely in the coming year, but history suggests Congress may soon view it as an economic imperative. From the mid-1980s to the mid-1990s, elevated nominal interest expenses led to several rounds of deficit reduction legislation, which ultimately resulted in a budget surplus in the 1990s.
A ‘forced tightening’ of U.S. and global fiscal policy would be a welcomed development, in my view, not only for its potential impact on long-duration rates but also because it would provide the Federal Reserve more leeway to ease from the current 5.50% upper bound fed funds rate. We also know from history that the Fed is more likely to cut rates quickly when debt servicing costs are high, as they are now.
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Disclosure