…There is a lot of talk about inflation and interest rates lately. “Inflation is running hot these days,” some say. “When will the Fed start to tighten monetary policy?” others ask. Yet, the elephant in the room (the Federal/public debt) rarely gets mentioned. My question is, how is the Fed going to raise interest rates when higher rates could make our government debt burden unsustainable?
The U.S. has a Federal debt-to-GDP ratio of 128%. That is relative to just 58% in 2000, and 35% in 1980. The United States now has one of the highest debt- to-GDP ratios in the world and we can expect the debt-to-GDP ratio to continue to increase but this…[is not a problem as] long as interest rates are kept extremely low…
Back…when the U.S. debt was at around 35% of GDP, the economy could withstand substantially higher interest rates…[but as] the U.S. debt perpetually increases, the 10-year Treasury and other interest rates head lower and lower so there is a clear correlation here. (Source: stlouisfed.org).
Due to enormous public and general debt obligations, the economy needs ultra-low rates to expand…therefore, regardless of inflation, we are likely looking at an ultra-easy environment for [considerably] longer…
The Fed can attempt to elevate rates modestly from here, but tightening comes with the added risks of throwing the economy into a tailspin and making the debt burden unmanageable (the lower the Treasury yield, the easier it is to service the public debt).
The Bottom Line
…The Fed is supposed to increase interest rates to combat inflation. However, this will be a difficult task given current economic dynamics:
- First, the economic environment is still relatively fragile, and any attempt at higher interest rates could derail this economic recovery.
- Moreover, with over $28 trillion in Federal debt along with multi-trillion dollar deficits, an increase in interest rates would notably increase debt servicing payments.
- A perpetual disconnect between tax revenues and government spending could make the national debt appear unmanageable and, in turn, this could lead to a crisis of confidence. Such a phenomenon would likely reflect very negatively on the U.S. dollar, as well as U.S. bonds, notes, and Treasuries.
To avoid such consequences…[an] ultra-easy monetary policy for an extended period by the Federal Reserve should take pressure off the Federal debt servicing payments and should enable economic growth to occur, and, should we see elevated inflation for some time, asset prices should continue to appreciate.
This is likely still a great time to own risk assets like stocks, commodities, digital assets, and other investment vehicles that should outperform negative-yielding inflation-adjusted bonds and other stagnant growth instruments.
Editor’s Note: The original article has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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