Everything You Need to Know About US Debt in Five Points
The national debt under President Obama’s administration doubled—from $10 trillion to $20 trillion, representing a 100% increase. However, the 2008 financial crisis piled more debt during the early years of his administration. With President Trump at the helm, the US debt has gone up over 10%. At the moment, the debt-to-GDP ratio is about to hit 110%. What could have led to this massive debt accumulation?
Before we can answer this pressing question, here are a few pointers to keep in mind:
- Since 2008, the US government’s debt has gone up by a whopping 154 percent to stand at $16.2 trillion.
- Outstanding non-financial US corporate bonds have increased by 67 percent to stand at $6.3 trillion, and this from just 2010. The Dallas Fed speculates that these funds may have been used in merger activities, dividends, and funding share buybacks.
- Central banks across the world are guilty of the interest rate compression witnessed after 2008 that resulted in huge debt accumulation by corporate and sovereign issuers.
Interest Spending on the Rise
The Office of Management and Budget (OMB) says that the US government is likely to pump more money into paying interest on debts. In fact, it says the figure will double in the next five years.
For instance, the government splashed $325 billion in interest in 2018. This is expected to rise to a staggering $664 billion in 2023, which makes up at least 13% of the federal government’s budget.
A Looming Economic Downturn
The Nationwide Retirement Institute says that a recession occurs once every five years, on average. It may be an inevitable occurrence, but the devastating effects, it tags along are not to be underestimated. According to the institute, the next recession is around the corner – 2019 to 2020. With this in mind, it’s important to prepare for when it hits. However, increased corporate debt doesn’t offer any reprieve, and this means only one thing. When the next economic downturn hits, there’ll be little to fall back on.
Since the last recession, corporate debt has skyrocketed to more than $9.7 trillion. That’s not the alarming part. Close to 50 percent (around $3 trillion) of investment-grade credit has acquired BBB status. This is just a single stage above the “junk bond” stage.
Note that this amount, the BBB percentage of the Investment-grade bond market, is over twice the high yield/entire junk index. In short, this means there’s more debt waiting for junk status.
Widening Credit Spreads in the Next Recession
The next recession is about to hit and according to financial experts, it will cause a widening credit spreads as corporations run to seek funding to salvage their businesses. This will be triggered by a bond fall to junk status from investment grade.
Slowed Economic Growth Due to Widening Credit Spreads
Morgan Stanley says that widening credit spreads will slow down economic growth and will also hamper employment. This will be similar to an overall increase in the Fed Funds rate.
This correlation indicates that widening credit spreads lead to an increase in unemployment. According to an International Monetary Fund report on global financial stability, a rise in credit and junk bonds led to reduced GDP growth in the 3 years following the Great Recession—up to 2 percentage points.
The Quest for Growth by Investors
Investors continue to look for new ways to increase revenues and expand their market reach. It’s this quest that has sparked an appetite for corporate borrowing. While borrowing is not bad, the Office of the Comptroller of the Currency (OCC) and the FED have sounded the alarm over the increased corporate borrowing that they term as risky.
In fact, according to them, lenders found via this website are lenient when it comes to the requirements during loan applications. It’s such actions that have caused the debt to reach record levels. At the moment, the corporate debt stands at 73 percent of the US Gross Domestic Product (GDP).
Junk and BBB bonds make up 67 percent of outstanding corporate bonds. This portrays a picture of weak credit quality. Going back in time, history shows default rates go up fast for junk bonds while debt rises, compared to GDP.
While this may seem like a threatening situation, various fixed-income strategists say the debt problems facing corporates may be less systemic and more company specific. This means many US corporates are still in the clear. According to them, the economy is in good shape. Tax reforms seem to be working for many people and taking a look into next year, general debt servicing will be more stable.
They also said it’s important to research various investments instead of going in blind. They attribute such lack of caution to the current economic climate although it’s always wise to diversify your portfolio.
With that said, there’s still danger lurking out there. Everyone must tread with caution, especially with the huge debt buildup witnessed in the last 5 to 7 years. An increased and risky corporate borrowing, increasing fiscal deficits, a potential for interest rates to rise along with slowing global growth provides enough fuel for an impending economic downturn, which may hit in 2020.