Saturday, October 22, 2022

How Safe Are Treasury Bonds?

 The recent sudden collapse of UK Gilts (government bonds) led me to write a post warning about black swans on the horizon. In it I mentioned US public debt, ie Treasury bonds.

Today, a chart that should have all of us worried.  It shows the relationship between federal debt as a percentage of GDP (green line), the market yield on 7-year Treasury bonds, chosen because the average maturity of federal debt is approximately 6 years (red line), and interest paid by the federal government as a percentage of GDP (blue line). All data are shown indexed to better observe the trends (1970=100).

While debt/GDP has constantly gone up and recently soared, debt service/GDP has been low because inflation was low, thus keeping interest rates very low. That’s obviously no longer the case, meaning that the US government will have to devote a much bigger portion of its budget towards paying interest.

Debt/GDP has tripled in the last 15 years and, when combined with sharply higher interest rates, will lead to a very rapid increase in debt service payments, certainly faster than in the 1980s, which were bad enough in themselves.

All other things equal, I expect debt service to at least triple over the next few years as older, cheaper debt matures and is replaced by debt carrying higher interest rates.  How long can the US afford this? How long before it falls victim to its own “Truss Moment”, perhaps caused by some new President who believes in even lower taxes?

This makes it IMPERATIVE for the Fed to kill inflation ASAP, whatever it takes. The alternative is the biggest black swan of them all: insolvency for the US.

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