By Daniel McGarvey, CFA, Portfolio Analyst, on behalf of Stonebridge Financial Group advisors
As our national debt exceeds $33 trillion, it is quite clear that our federal government’s spending habits are unsustainable. To put the number in greater context, our total public debt now sits at almost 120% of GDP, a historically high ratio that shows our economy is not producing enough to warrant what we are spending. It is to be expected that nations will have higher borrowing during times of unrest, like the pandemic, but politicians on both sides of the aisle are now far too willing to continue spending in both good times and bad without considering the consequences. The Congressional Budget Office is projecting that this trend will only get worse:
With the Federal Reserve increasing rates, the government is also now facing a major increase in interest payments, which could lead to currency devaluation if we do not significantly decrease the numerator or increase the denominator of the debt/GDP ratio. As shown below, about 30% of fixed-rate marketable U.S. debt is maturing or has matured in 2023, meaning that a considerable amount of new debt will replace it with much higher nominal rates of 4-5.5%. If economic growth cannot outpace these rates, interest servicing costs could consume the federal budget.
An argument could be made that the debt issue is more attributable to insufficient tax revenues than it is to over-spending, but tax revenue in relation to GDP is the highest it has been in over 20 years. Either way, there is a growing mismatch between spending and revenues that needs to be addressed, and neither solution (higher taxes or less government assistance) sounds attractive to consumers who have been battling inflation for years. One could also argue that higher treasury rates could stimulate the economy by giving consumers higher income, but that effect is less significant when inflation eats away at it. In addition to the debt problem, the government’s poor budgeting has created massive unfunded promises for Social Security and Medicare. These programs’ actuaries estimate that the present value of the unfunded benefits are $60 trillion and $103 trillion, respectively.
Although the most obvious, and possibly most needed, solution is to stop increasing government spending, the problem could also be mitigated with substantial economic growth that naturally increases revenues. Alternatively, other world economies could lag ours and leave us as the “cleanest dirty shirt in the laundry.”
We do not think the situation is dire at this point, and we have no reservations about holding U.S. treasuries given that they are still the safest investable asset, but politicians cannot kick the can down the road forever. We sincerely hope to see some more fiscal responsibility in Washington so that future generations do not have to pay the large bill.
October was the third consecutive negative month for stocks, as the S&P 500 returned -2.1%. The Bloomberg US Aggregate Bond Index had its sixth consecutive negative month, returning -1.6% as the 10-Year Treasury rate hit 5% for the first time since 2007. The Federal Reserve chose to keep rates steady at the 525-550bps range while keeping the door open for more hikes if necessary.
Charts provided by Congressional Budget Office, Federal Reserve Bank of St. Louis, and YCharts, Inc.
Material discussed is meant for general/informational purposes only, and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary, therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Daniel is a Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.