by Bryan Perry
December 28, 2022
So much of the Fed’s narrative surrounding inflation is focused on the upward pressure on wages and the cost of professional services. This was once again reflected in last Friday’s release of the Personal Consumption Expenditures Index (PCE), the Fed’s favorite inflation indicator.
What is never brought up at the post-FOMC (Federal Open Market Committee) press conferences is what I liken to the proverbial “elephant in the room” – namely the $31 trillion in federal debt that is growing to where it will top $41 trillion by 2026 if some severe budget-cutting by Congress isn’t taken fairly soon.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
As of November 2022, servicing the federal debt accounts for 11% of total federal spending, and last Friday’s passage of $1.7 trillion of new spending will only add to the national debt
I think part of what the Fed is terrified of is seeing short-term interest rates stay elevated for an extended period. They fund the interest on the debt by issuing 1-, 2-, and 3-year Treasury Bills and Notes. After seven rate hikes in 2022, yields on these securities are now averaging around 4.5%.
Simple math says that 4.5% of $31 trillion is $1.4 trillion, or something close to 25% of the annual budget, and a figure we weren’t supposed to see until the mid-2030s, according to the chart below.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
This past May, the Congressional Budget Office (CBO) projected that annual net interest costs would total about $400 billion in 2022 (reflected in the chart above), and nearly triple over the next decade, soaring to $1.2 trillion annually and adding up to over $8 trillion over the next ten years. Bear in mind this forecast was done back in May, when interest rates were lower than where they are today.
This presents a major dilemma for the Fed. As short-term rates rise, it makes Federal borrowing to service the elephant-sized debt way more expensive. The growth in interest costs presents a major challenge over the long-term. According to the CBO’s model, interest payments could exceed $66 trillion over the next 30 years, absorbing nearly 40% of all federal revenues by 2052 – becoming the largest federal expenditure, exceeding defense spending in 2029, Medicare in 2046, and Social Security in 2049.
One could argue the Fed needs to wreck the economy to get inflation and interest rates back down to 2%, in order to “save the government” from its own folly. Spending for education, transportation, R&D, and other programs will be dramatically impacted if revenues aren’t increased, and spending decreased.
With the assumption that Congress has no intention of reducing the rate of spending, the only way to balance the budget is to bring rates back down to deflationary levels and raise taxes on personal income, corporate sales, and all manner of products and services. The current U.S. debt/GDP ratio is about 120%.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
In Japan, government debt-to-GDP stands at 262%, and that economy hasn’t seen normal growth since 1995. This multi-decade period of slow-to-no growth in Japan should set off alarm bells at the Fed and on Capitol Hill. It’s the biggest challenge the Fed faces, and that is why they are crushing the economy after they blew it with their 2021 “transitory” stance on inflation that unleashed this now-hawkish policy.
Months before the Federal Reserve began raising rates to combat inflation, former Treasury Secretary Larry Summers warned that inflation was already a problem and would get a lot worse in 2022. Summers, a fixture at Harvard and one of the most influential economists of our time, serving both the Clinton and Obama administrations, has repeatedly sounded the alarm over rising inflation. He spent much of 2021 arguing that the Biden administration and the Fed have underestimated the risk of soaring prices.
Sometimes, when the smartest guy in the room is talking, those in charge should be listening.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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