There are strong economic arguments for Washington and its creditors to pursue a restructuring of US federal debt, however strange it sounds. This becomes clear when considering the supply and demand for US treasuries over the next four years and the repercussions of doing nothing. Now may be the time for President Donald Trump to prepare a deal.
Again, as with the abandonment of the Iran nuclear deal, observers could not say they had not been warned. In 2016, when he was simply the presumptive Republican presidential candidate, Trump answered a question on CNBC television about whether he might wish to renegotiate America’s public debt by saying, ‘I would borrow, knowing that if the economy crashed, you could make a deal.’
The US economy is caught in a debt trap. Avoiding a major economic downturn requires alleviating the burden of servicing public and private debt. The key is restructuring federal debt, which will diminish the country’s net interest burden.
The federal budget deficit is around 3%. Depending on growth, federal revenues and changes in interest rates, it may be as high as 6% by 2022. Consequently, the supply of treasuries will go up and reach almost double what it has been over recent years.
The main buyer of treasuries has been the US Federal Reserve System, which holds close to $2.5tn, more than China and Japan combined. For several years the Fed bought treasuries to stimulate the US economy, but it is beginning to tighten monetary policy.
The other main holder of US treasuries is neither China nor Japan, but federal agencies, at around $5.6tn. These agencies buy treasuries using excess tax revenue. Small changes in the business cycle will influence this revenue, hampering their purchases of treasuries. Even putting a small share of the $8.1tn worth of treasuries that the Fed and federal agencies hold on the market may have a significant impact. Some may view this as the Fed and federal agencies abandoning the government.
The remaining treasuries (around $6tn) are held by various investment funds, banks, the public and other countries. It is difficult to see why these creditors should boost their purchases, unless US policy-makers engineer a substantial increase in interest rates.
Since that the average maturity of outstanding US marketable securities is between 60-70 months, around two-thirds of treasuries will have to be renewed or rolled over before 2022. The main share of outstanding treasuries has been sold from 2011 onwards, and since then the yield of the benchmark 10-year treasury bond has fluctuated between 1.4%-3%. By 2022 around 60% of debt will have been financed at a higher interest rate than the treasuries it replaced. If the economy continues to grow and interest rates do not rise sharply, the ship may not capsize. But such circumstances cannot be guaranteed.
Rising interest rates will damp growth. Private consumption is in large part supported by consumer debt. Credit card debt is at a record high $1tn and rising. Non-financial corporate debt is at its highest since 2008, close to 45% of GDP. Many corporates took the bait of low interest rates and issued bonds. Now they face either paying back the debt, which requires them to have the cash, or rolling it over at a much higher interest rate.
The time to broach a deal with creditors may be approaching. They may be forthcoming so long as the US refrains from excessive protectionism and its economy keeps growing. Herein lies the danger. If the Fed tightens its policy too quickly, the economy may derail in a couple of years.
Waiting until, say, 2022 when debt spirals out of control is not a good option. Trump should think about acting now.
Joergen Oerstroem Moeller is Senior Research Fellow, ISEAS Yusof Ishak Institute, and a former State Secretary at the Danish foreign ministry. This is the second article in a series of two articles on US policy and the restructuring of its sovereign debt. The first article was published on 10 May.