Can The U.S. Afford Its National Credit Card?
By Garritt Conover and Orhan Imer
December 13, 2012
With U.S. national debt at all time highs and major Federal programs expiring within weeks, it is no surprise that the focus of investors following the election has quickly shifted back to the upcoming fiscal cliff. Fears of an insolvent government or a U.S. debt crisis have sparked heated debates regarding ways of tackling the budget deficit â€” but just how imminent a threat does it pose?
Undoubtedly, the U.S. government has accumulated massive amounts of debt since the recession began, with a $1.3 trillion deficit in fiscal 2011 and $1.1 trillion in fiscal 2012. Exceptionally low interest rates, however, have allowed interest expenditures to remain low relative to tax revenues and gross domestic product (GDP) despite the increase in debt. Thus, despite large running deficits, debt has created less of a drag on the taxpayer and the economy compared to eurozone countries grappling with their own debt concerns.
Unfortunately, this relationship only holds as long as rates remain depressed. Through aggressive government purchasing programs as well as a global economic downturn, U.S. Treasuries were able to maintain extraordinarily low interest rates for several years. Current forward rates imply that investors expect short-term rates to continue to remain low â€” below 2% for an additional five years.
Assuming the maturity distribution of U.S. debt is held constant by rolling debt as it matures, we modeled refunding needs, weighted average yields and interest burden on taxpayers under the president’s budget plan over the next 10 years. Interest costs currently consume 10.5% of tax revenue. Using forward rate-implied future borrowing costs, this measure increases only modestly over 10 years. The interest burden falls in 2013 and 2014, only surpassing the current level in 2018 and reaching just over 12% in 2022. Implementing immediate rate shocks, however, we found that future sustainability is very sensitive to increases in rates. An increase of any more than 100 basis points results in progressively increasing interest costs relative to tax revenues, and at 300 basis points the ratio nearly doubles in 10 years (Exhibit 3).
The run-up in debt has made the economy very susceptible to interest shock events, and an unexpected increase in rates could have severe effects on the U.S. economy in the long run. As long as rates continue to remain low, however, temporary deficits during the recession will continue to have little impact to the debt burden on taxpayers. Furthermore, even in a rising rate environment, it takes a relatively severe shock and several years for U.S. interest coverage ratios to reach levels similar to countries currently facing debt crises.
Ultimately, while the national debt and Federal deficit are issues which must be addressed, fiscal cliff worries in the near term may be exaggerated.
The views expressed are as of 12/10/12, may change as market or other conditions change, and may differ from views expressed by other Columbia Management Investment Advisers, LLC (CMIA) associates or affiliates. Actual investments or investment decisions made by CMIA and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results and no forecast should be considered a guarantee either. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts are accurate.
This material may contain certain statements that may be deemed forward-looking. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those discussed. There is no guarantee that investment objectives will be achieved or that any particular investment will be profitable.
Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Securities products offered through Columbia Management Investment Distributors, Inc., member FINRA. Advisory services provided by Columbia Management Investment Advisers, LLC.
Â© 2012 Columbia Management Investment Advisers, LLC. All rights reserved. 148974
(c) Columbia Management