The dramatic rise in interest rates over the past few years has caused widespread economic fears as individuals, corporations, and Banks all have to pay higher rates on debt loads, which have skyrocketed since the beginning of the pandemic. But what about the world's single largest deor, which is the US government? In the past two decades, the government's debt load surged reaching $33 trillion in 2023. The government is expected to pay $640 billion servicing its debt, but as the debt is refinanced at higher interest rates, this will increase to 1.3 trillion or more than a quarter of total tax revenue. Despite the seemingly dire budget situation, the government has made no effort to slow the rate of spending and the budget deficit is projected to remain well above $1 trillion per year for the foreseeable future.

The Situation's gotten so bad that in August the ratings agency Fitch downgraded the US government's credit rating, citing the growing debt burden in and generally incompetent leadership. The numbers look scary with government debt representing $300,000 for each household in the country. As the debt continues to grow, this burden will be pushed on to Future Generations. But this is not a universal view.

According to former Federal Reserve chairman Alan Greenspan the US will never default on its debt because we can always print the money. This sounds too good to be true. Does the government really have an unlimited credit card, allowing it to rack up trillion dollar deficits with impunity? While the acies of economic policy and national debt may seem overwhelming, they're rooted in systems governed by rules and numbers, much like the stem fields to navigate our future. Whether it be understanding the economy, building the next big Tech Innovation or simply making more informed decisions, it's essential to sharpen our minds in these critical areas.

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In 2023, the Congressional Budget Office published a long-term Deb debt forecast which raised concerns among media pundits and politicians. The House Budget Committee released an alarmist statement saying that each household share of government debt will reach $1 million by 2053. $1 million seems like an unimaginable amount of money for an average household, but what exactly does this mean? and how did we get here? The most common way to look at government debt is as a percentage of GDP the government raises Revenue by taxing the economy. The larger the economy, the more affordable any given debt load is.

the budget deficit is a difference between the money the government spends and what it brings in. Over the past 100 years, the budget has almost always been in a deficit. During the Second World War, the deficit was massive as the government borrowed money to fund the war effort and tax revenues decreased. As a private sector shrank for the next few decades, the budget was roughly imbalance.

In fact, there was a slight deficit in most years. Despite this, the debt to GDP ratio steadily fell. as the economy grew faster than new debt was accumulated. In the decades following the Second World War, the debt to GDP ratio stayed relatively stable.

It wasn't until the 2008 Financial crisis that we saw a major increase as the government spent heavily on unemployment insurance in various stimulus programs. In 2020, the debt level skyrocketed again as a result of coid related economic stimulus, which was unprecedented in scope and scale. You can see a pattern of the debt level increasing during times of Crisis be it World War 2 the Global Financial Crisis or the pandemic. What's changed recently is that despite the pandemic being over, the government has continued to rack up what appear like excessive deficits.

Not only that, but with interest rates Rising, these deficits will become more expensive to finance. The Congressional Budget Office expects the deficit to increase from about 5% of GDP in 2023 to 10% of GDP over the next few decades. With a majority of this increase coming from higher interest expense, The total government debt is expected to rise from 100% of GDP today to almost 200% by 2050. Critics of deficit spending argue that we're current currently living beyond our means, and eventually there will be a reckoning.

watching The Debt Clock tick up $1 trillion at a time is viscerally scary, and it seems that at some point we will have to pay for our fiscal irresponsibility with interest. For decades, politicians have leveraged this fear to criticize their opponents, saying that the opposing side's policies are bringing the country to financial ruin. Yet, regardless of political party, every one of the past four presidents has borrowed more money than the last, and there still hasn't been a debt crisis. Charts like this look scary.

It looks like America is recklessly heading towards a self-inflicted catastrophe. But as we will show taken out of context figures like debt to GDP can be almost meaningless, and America's government debt situation is not nearly as dire as some TV pundits might want you to believe. The projected growth in the deficit over the coming decades is primarily driven by higher interest expense. As the level of debt increases the amount of money the government needs to the services debt increases along with it.

So where will this money come from? It will come from issuing even more bonds and further accelerating the rate of debt accumulation on its face. This sounds unsustainable. Let's say you have credit card debt and you borrow even more money to make your interest payments as your debt accumulates. Eventually, you'll reach your credit limit and your card will stop working.

It's similar. for a corporation, they could issue more bonds to pay the interest on their existing bonds, but as their debt level increases, their credit rating will be downgraded and investors will demand higher interest rates for newly issued bonds. Eventually, the company's credit quality will become so bad that nobody will lend them more money no matter the interest rate. At this point, it's game over.

If they don't have the cash to make their interest payments, they will go bankrupt. The government issues bonds as well. For the government to go bankrupt, it would need to find itself in a situation where nobody buys its bonds. But this will never happen.

If all else fails, the Federal Reserve is always standing by able To buy however many bonds the treasury wants to sell, and the the Federal Reserve has a printing press so it can never run out of money. That's why Allan Greenspan said that the US will never default on its debt. The government doesn't print money itself, but it can theoretically borrow an infinite amount of money from the Federal Reserve. The Federal Reserve is independent.

It is supposed to set interest rates to attain its policy objectives of 2% inflation in maximum employment. It does not formally have a mandate to accommodate government budget deficits, but in practice, that's exactly what it does. The Fed's main policy tool was the Federal Funds rate, which is the rate at which banks can borrow cash from each other for short durations, usually for a few days at a time. Short duration treasury bills must trade at yields similar to the Federal Funds rate.

If the yield on a treasury bill maturing within the next couple weeks traded at a significantly higher yield than the Federal Funds rate, Banks would borrow at the Federal Funds rate to buy that treasury bill. This would increase demand for treasury bills and bid up the price until the yield reaches the Federal Funds rate. While the mechanism is a bit convoluted, this effectively means the treasury can issue an unlimited amount of bonds because the FED is always there as a back stop. Let's look at a hypothetical example.

The FED sets the Federal Funds rate at 5% This is the rate at which banks can lend and borrow money from each other for short durations. As we explained earlier, the yield on short-term treasury bills has to be 5% as well as the banks are indifferent between lending to each other and lending to the government. As the Government: Issues New treasury bills. The banks will buy them.

This decreases the bank's cash reserves, The Federal Funds rate is based on supply and demand, and as the cash Reserves at the bank decrease, they will have less cash to lend to each other, and the Federal Funds rate has to increase. But the banks don't decide the Federal Funds rate. the FED does. As the FED sees the Federal Funds rate creeping above its Target It will print new money and buy bonds from the banks.

This will cause the cash Reserves at the banks to increase, giving them the money to buy the newly issued treasury bills. Because the FED can print an unlimited amount of money, the government can sell an unlimited amount of treasury bills, and they will always be able to sell them at or near the Federal Funds rate. The Federal Reserve does not directly lend money to the government. it's instead laundered through commercial Banks But the end result is the same.

Let's use the credit card analogy again. if your card has no limit, you can theoretically spend as much money as you want and always borrow more money to pay the interest. Your debt balance and interest expense become irrelevant because you can always just borrow more money. People have a hard time wrapping their head around this because it sounds too good to be true.

How can anyone, even the government possibly borrow unlimited money? It absolutely is true. All the excitement about the debt ceiling is pure political theater. As long as Congress allows, the government can borrow an unlimited amount of money and never go bankrupt. But just because you can doesn't mean that you should.

Allan Greenspan is right that the US will never default on its debt, but excessive spending still has real consequences. There is no free lunch. Every dollar the government spends is ultimately paid for by the people, but the way it is paid for is a bit convoluted. If the government borrows money to build a tank, Factory It employs people and takes up resources.

Had the tank Factory not been built, these workers would be doing something else. Maybe they'd be building refrigerators or washing machines because they're building tanks. Instead, the supply of refrigerators decreases and the price increases. As another example, the enhanced unemployment insurance during the pandemic was paid for by government borrowing, which was ultimately financed by the Fed People use the unemployment insurance to buy groceries and other essential items.

This is despite the fact that they weren't working at the time so weren't contributing to aggregate production. This also pushes prices up. All of this is inflationary, and sure enough, in 2021 and 2022, we saw Consumer Price inflation surge to as high as 9% The Federal Reserve is independent and has a mandate to bring inflation down to its 2% Target To do this, it was forced to raise interest rates dramatically. The government is the largest borrower, but as we established earlier, it can borrow an unlimited amount of money, so higher interest rates have no direct effect on its ability to finance its budget deficits.

The pain of higher interest rates is only felt by the private sector. For example, pre pandemic. The average 30-year mortgage rate for a borrower with a perfect credit score was about 4% For a $200,000 house, this would cost you about $950 per month. Now, mortgage rates have doubled to 8% This same house will now cost you $1,500 per month.

Thus, now you have to either buy a smaller house or cut back on other expenditures to afford your higher mortgage payment. And everything else you buy is more expensive as well. Thanks to the high inflation over the past couple years, When you hear politicians complaining that large government deficits are saddling future generations with an excessive debt burden, they are wrong. There's never going to be a bill coming due for future generations to pay.

That's because we're already paying for the government deficits today. Interest rates in consumer prices are far higher now than they would have been had the government not borrowed trillions of dollars during the pandemic. Your mortgage payments and grocery bills are real expenses. just as real as the money of the IRS deducts from your paycheck each month.

It's just not on your tax return. Even if the government continues to recklessly borrow money, it won't result in a debt crisis so long as a central bank remains independent. It won't cause hyperinflation either. Instead, it will necessitate oppressively High interest rates, which will hamper investment in the private sector.

If the government can borrow an unlimited amount of of money, you might wonder why do we even need to pay taxes? The main reason is that tax rates can be Progressive. Most people agree that wealthy people should be asked to pay a larger share of their income than a poor family who is barely scraping by the cost of high interest rates, on the other hand, is born equally by everyone, regardless of their ability to pay. While the costs of government deficits are real and should not be forgotten, the US will not find itself in a debt crisis, at least not anytime in the foreseeable future. If you look at government debt crises in recent decades, they almost always result from one of two reasons, neither of which are applicable to the US.

For example, Greece had a disastrous debt crisis between 2009 and 2018, which saw multiple defaults in Draconian austerity programs. Greece is a member of the Euro zone They Don't print their own money so their Central Bank cannot act as a back stop in the way that the Federal Reserve does. for the US Greece's government finances are much more comparable to that of a private sector company. They can go bankrupt if investors decide they have become too risky and refuse to continue lending.

Countries with their own currencies can also have debt problems. For example, both Turkey and Argentina are currently suffering from extremely high inflation and collapsing currencies. In both countries, the central banks are not sufficiently independent. The government was running large deficits.

In such a situation, the Central Bank should have raised interest rates to slow down the private sector and effectively make room for the large government spending. but instead the government pressured the central bank to keep interest rates low to stimulate the private sector. They were trying to have their cake and eat it too. The results were predictably disastrous.

The situation in Argentina is even worse. They also wanted to finance budget deficits without burdening the private sector with high interest rates. The way they did this was to issue Bonds denominated in US Dollars. This influx of foreign currency allowed Argentina to finance its debts without needing to increase its own currency Supply which would necessitate higher interest rates to keep inflation stable.

The problem is, they had no realistic plan of how they were going to pay back their International creditors. They resorted to printing pesos to buy dollars. This created a death spiral. As the peso depreciated, they needed to print even more pesos to pay their US dollar interest which caused even more depreciation and so on.

The US is in a completely different situation. The Central Bank is independent. They have aggressively raised interest rates in the face of above Target inflation. This will prevent hyperinflation regardless of how much money the government continues to borrow.

All right guys, that wraps it up for this video. What do you think about the US government's growing debt? Let us know in the comments section below. As always, thank you so much for watching and we'll see you in the next one. Wall Street Millennial Signing out.