American debt is on the verge of breaking a record. The combination of cheap money and skyrocketing debt has helped fuel the a decade of economic expansion and bull market, but America’s greed for loans could work against it if its fragile economic equilibrium were to change.
In the first quarter of 2019, total U.S. public and private sector debt stood at nearly $ 70 trillion, according to a study by the Institute of International Finance. Federal government debt and the liabilities of private businesses excluding banks have both reached new highs.
Debt itself is not bad. Borrowing can help governments and businesses grow by financing important projects and services that strengthen the economy. And for now, the United States can still cope with its debt burden. The economy, which is about $ 21 trillion in size, remains healthy and the Federal Reserve is preparing to cut interest rates and make debt even cheaper. But America’s near record liabilities could be dangerous in the future.
The US economy is starting to show cracks. Manufacturing slows and the trade war is hurting economies around the world.
The United States remains one of the most attractive places to invest, and its sovereign debt continues to be a safe bet for investors. But if the economy slows, the United States will have to continue to rely on investors – and especially foreign countries – to buy its bonds.
It will probably happen again. But the United States is not making it easy.
The the government could run out of money by early September, before Congress returns from its summer recess, the US Treasury Department said on Friday. This is why Treasury Secretary Steven Mnuchin called for Congress to raise the debt ceiling before summer vacation. Talks between Mnuchin and House Speaker Nancy Pelosi have been productive, the Treasury Secretary said on Monday.
The government has not been able to borrow money since March, due to borrowing limits imposed by Congress. If a fractured government does not raise or temporarily suspend the debt ceiling, the United States could default on its debt, increase its borrowing costs and potentially plunge the global economic system into chaos.
America has a lot of debt to pay off. The Treasury Department has indicated that the the budget deficit jumped by more than 23% between October and the end of June, expanding by some 750 billion dollars. This is in part due to President Donald Trump’s tax cuts in 2017. US debt hits a new record due to rising government borrowing, which now stands at 101% of GDP, according to IIR.
In the long run, however, the easing of financial conditions by central banks, including the Federal Reserve, “will support further debt build-up, exacerbating concerns about the debt service burden and sovereign debt sustainability.” wrote IIR analysts led by Emre Tiftik, deputy director of Global Policy Initiatives.
The Fed is expected to cut interest rates at the end of the month.
But the rate cut will only help to reduce the interest burden on the United States, which stood at $ 830 billion annualized in the first quarter. If the Fed cut rates by 100 basis points, or 1%, that bill could be $ 20 billion to $ 25 billion a year lower, the IIR said. It’s no small feat, but the interest remains a financial burden on the United States.
Investors were already worried last year about the so-called double deficit – including the US budget and current account deficit, or the country’s global trade gap. Although the market has moved on to other problems, the double deficit is still alive and continues to grow.
The debt situation of American companies is not much better.
An increase in bank lending has taken non-financial corporate debt to new highs: 74% of GDP, according to the IIR.
With the Fed preparing to cut interest rates, this trend is unlikely to reverse. Lower rates could give heavily indebted companies a sigh of relief as it becomes cheaper for them to refinance. But it will also invite companies with poor credit profiles to continue to borrow cheaper on the open market.
US corporate profits are expected to have fallen in the second quarter – the second consecutive decline. And Wall Street analysts expect that to happen again in the current quarter. This means that some companies may not be able to repay their debt if the market and the economy deteriorate.
“Growing concerns about the earnings outlook underscore the risks for highly leveraged companies,” analysts wrote.
A higher debt burden will do little to improve business confidence and investment, which have already been hit by the trade war.
Concerns about rising debt levels are not confined to the United States.
The global borrowing balance stands at over $ 246 trillion, or nearly 320% of global GDP and just below the record high it reached in the first quarter of 2018. This means that in the together, the world borrows more than it produces. It’s living beyond your means, so to speak. Such a cluster puts the world – and emerging markets in particular – at risk from abrupt changes in market conditions.
If conditions change quickly, it could be more difficult for countries with lower credit quality to refinance their outstanding debt.
Borrowing is expected to increase as central banks in developed markets reorient their policy towards an easing mode. This could undermine “debt relief efforts and rekindle concerns about long-term headwinds for global growth,” the IIR said.