U.S. Treasury Yields Skyrocket, What Are The Consequences?

Interest rates have risen sharply over the past year, fuelling that Speculations on the sustainability of the U.S. national debt. Since 2008, this national debt has tripled in absolute terms, from about $10 trillion to $30 trillion. Relative to the size of the economy, the debt burden has almost doubled in this period, from 63 to 121 percent of gross domestic product. But what does last year's rise in interest rates mean for public finances? Will the United States go bankrupt or will it still be able to easily pay the interest charges?

At the time of writing, the U.S. government is paying 3,66% interest to borrow money on the capital market for ten years. That's almost twice as much as a year ago, when investors settled for 1.8%. In the rest of the world, too, interest rates rose sharply last year. And that also has consequences for governments, because it means that they have to pay much more interest when they borrow more money or want to roll over existing loans. However, how much that hurts also depends on the average duration.

How high is the U.S. national debt?

The U.S. national debt has increased dramatically in recent years. Things went particularly fast during the corona pandemic, when tax revenues fell and the government spent much more money to support the economy. The financial crisis of 2008 pales into insignificance compared to the additional fiscal stimulus that the US government has administered to the economy in recent years. The graph below shows the almost exponential rise in public debt.

U.S. national debt has skyrocketed (Source: St. Louis Fed)

Interest charges skyrocket

The chart below shows that effective interest charges on the national debt increased by almost 40% in a year to about $850 billion. This is based on the assumption that interest rates will remain at current levels for the rest of this year and that a larger part of the debt will have to be rolled over at the current interest rate. If interest rates remain at this higher level next year, effective interest charges will rise even further. This involves hundreds of billions of dollars in interest that the government then has to cut back on other expenses or borrow extra. In the latter case, the creditworthiness of the United States will come under further pressure.

The increase in interest charges is a gradual process, because a large part of the national debt is borrowed for a longer period of time. Compare it to the mortgage interest rate, which can be fixed for a longer period of time and therefore does not move with the market interest rate.  Of the total U.S. national debt, 37% matures within a year, 35% between 1 and 5 years, 15% between 5 and 10 years, and 12% more than 10 years. The average maturity of all U.S. Treasury bonds is currently 62 months, a little over five years. These figures provide more insight into how the U.S. government has financed itself and how quickly higher interest rates cause problems. Interest rates must therefore remain high for years before they have to be paid for the entire national debt.

Effective interest rates on U.S. government debt skyrocket if interest rates remain high for longer (Source: St. Louis Fed)

How worrying is this?

In absolute terms, the rise in interest rates looks threatening. However, if we look at interest payments as a percentage of the US economy, the trend looks less frightening. Due to the extremely low and ever-decreasing interest rates of recent years, the US government has been able to lock up a large part of its debt at favourable interest rates. As a result, the effective interest rate currently paid by the U.S. Treasury Department is less than 2% of GDP, as the chart below shows. This is less than in the early 1990s, when effective interest payments amounted to around 3% of GDP.

Interest rates as a percentage of the total economy are still low (Source: St. Louis Fed)

Despite the doubling of the debt-to-GDP ratio, interest payments have remained stable. That trend now seems to be reversing. Interest costs are rising again and that could become a problem if interest rates remain high for longer. For example, doubling interest charges is already equivalent to half of U.S. government spending on Medicare, the U.S. government's social health insurance program.

What's next?

In late May, the Congressional Budget Office (CBO) predicted that annual interest expenses in 2022 would be around $399 billion and nearly triple in the next decade, from $442 billion to $1.2 trillion a year. Over this period, total interest expenses will be $8.1 trillion. However, if inflation is higher than the CBO's forecasts and market interest rates rise more than the agency expects, then those costs could rise even faster. The Peter G. Peterson Foundation summarized these figures in the graphs below and calculated that interest payments would rise to 40% of GDP in thirty years at the current trend. In 2029, the interest on the national debt will already be a bigger cost for the US government than the Ministry of Defence.

In the short term, rising national debt and interest costs are not yet a problem, but in the longer term they could undermine confidence in US public finances. The public finances of the United States are already not exactly healthy due to structural budget deficits. This problem will only get worse if additional interest charges are added. Cuts in healthcare, education and defense, for example, are not popular and not so likely under the Biden administration. The national debt will therefore increase even further in the coming years and with it the interest charges.

Expected increase in interest expense (Source: Peter G. Peterson Foundation)

Expected increase in interest charges as a percentage of GDP (Source: Peter G. Peterson Foundation)