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Thoughts about Debt, Deficits and Inflation Thumbnail

Thoughts about Debt, Deficits and Inflation

“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” 

– Vladimir Lenin


This just in:  Russia and Ukraine are locked in what appears to be a long miserable war, Israel is struggling to rally support among its allies to eliminate Hamas and the United States has issues: at the border, congress, and in the upcoming Presidential elections!  

Lost among all the competing news is national debt statistics like these:  $34 Trillion in national debt.  That equates to almost $102,000 for every citizen in this country!  That debt is largely in the form of outstanding bonds with interest which now averages about 3.15 percent – up from 1.56 percent in January 2022.     

The debt is growing fast – because like family finances if you are spending less than you are taking in you must fund the difference with debt.  It’s no revelation that Covid increased federal spending and the debt – but we have recently added an accelerant to bad spending behavior of the past.

This federal spending has produced inflation.   Inflation tends to become persistent once it becomes embedded.  It becomes part of every family and businesses’ expectations.   IE: There’s been inflation in the past so…” I need to get a raise at work” or “raise prices for my products and services” or “I need to raise rents for housing”.   That in turn produces more inflation…

Why is that a problem?   

Inflation is bad in many ways. It erodes spending power - making life challenging for those whose incomes are fixed - which tends to be the poorest among us.   

The problem with “fighting” inflation is that there is only one effective tool – and it is both powerful and blunt.  That tool is interest rates and the entity which wields the power to both raise and lower those rates we know as the Federal Reserve or “Fed”.  

Since 2022, the Fed has sought to crush inflation by raising interest rates.  While they have succeeded to some extent, the Fed is not satisfied until inflation is down around 2 percent.  While we have come a long way – the last vestiges of inflation will be the most difficult to get rid of as evidenced by recent data.  

Much of the discussion about the Fed raising rates has centered on killing home purchases for a public which is used to 3% mortgage rates.  However, I think the bigger issue is one that is seldom discussed and more problematic long term: the cost of funding service for an ever-increasing U.S. debt.

For fear of making this discussion more esoteric than it needs to be – let’s just say it costs a lot more to service $34 TRILLION in debt when it’s financed at 5% as opposed to 1%!

Unfortunately, while we had very low rates for a long time the treasury failed to issue much of that debt as 20 – 30-year bonds, a fact that one respected hedge fund manager calls “the biggest failure in the history of the Treasury Department”.  While most Americans refinanced mortgages during that period to exceptionally low rates, the Fed was one entity that failed to extend the maturities of its debt – which could have ensured low rates on outstanding debt long into the future.  In fact, most debt was issued as maturities of 1-5 years with almost 1/3 of it coming due this year!  

Unfortunately, that outstanding debt will be replaced by debt which averages between 4.5 – 5.5%.  Who pays for that difference?  You guessed it – the taxpayer.

The convergence of these two things is problematic.  1) The debt is growing because the government spends more than it brings in and 2) the rate at which we are financing that growing debt is tripling in short order.

Using the analogy of family finances:  We have a very large credit card will that we can’t pay off and thus we add to it. In addition, the interest rate on that debt is tripling in short order.  

Unfortunately, most of those in power want to stay in power and solving this problem means spending less and accepting high rates for long enough to put a fork in inflation expectations (usually accompanied by a recession).

I don’t know when things will become a big enough problem to warrant action by national leaders.  I worry it might blow up before they are willing to act.  Regardless, I encourage investors to be both humble and data dependent as they make decisions which will have a huge impact on their families’ quality of life for decades to come.