Once upon a time, being in debt up to your eyeballs was bad. Years back, I remember chatter and gossip about people and companies burdened by debt. Nowadays, this has changed; no such shame exists.
Debt is now considered a meaningful way to achieve growth, partly because of the long period of low interest rates. During this time, you often heard the term “free money.”
Debt surrounds us, whether by debt-laden companies teetering on bankruptcy, consumers’ household finances being consumed by high-interest credit, or the federal government overloading on debt. Debt is now part of our culture. America is a debt-driven economy within all aspects of life.
The consumer’s life is fueled by debt. That is obvious. This is how consumers can afford all the goods they want. If consumers are responsible with household debt, there is no problem, but we all know excessive debt limits financial freedom and traps people in a cycle of never-ending monthly payments.
The most recent example of runaway debt within consumer markets is the automobile market. According to Edmunds, an auto industry research company, “nearly 15 percent of drivers who financed a new vehicle toward the end of 2022 are paying more than $1,000 a month. About 5 percent of consumers who financed a used car during that period are paying north of $1,000.” Both of these numbers are record highs.
Concerning debt in the corporate world, private equity is perhaps the best example. Private equity (PE) firms tend to use leveraged debt to buy target companies. Years later, what often happens is that the company is loaded with so much debt that it needs to restructure, or even worse, it goes completely bust. It’s so widespread that a well-known cottage industry has sprung up around it, specializing in packaged bankruptcy filings, complete with prearranged debtor-in-possession financing.
Out-of-control corporate debt also creates zombie companies (barely alive, just coasting), ultimately hindering any hope of corporate reinvestment or profitability. Last year, many PE firms were borrowing at 19 percent annual interest.
While PE firms have managed to stay afloat and dodge liquidity issues, commercial real estate is taking a severe hit. Many analysts and investors have been waiting for the proverbial shoe to drop regarding commercial real estate. Luckily for landlords, so far so good. Perhaps landlords are getting by with interest-only payments.
Consumer and corporate debt aside, government debt is the real risk. As the Council on Foreign Relations reported in December 2023, “years of elevated budget deficits, exacerbated by massive federal spending during the COVID-19 pandemic, have taken the debt to historic levels: totaling more than $26 trillion in 2023, U.S. federal government debt is now at its highest percentage of gross domestic product (GDP) since World War II.”
We are back to World War II debt levels!
As I wrote late last year, interest costs on U.S. government debt have soared to $659 billion in 2023, up by $184 billion, a 39 percent increase from the previous year, and almost double the amount from 2020. This is significant, to say the least.
The decision to issue government bonds is a policy choice for managing interest rates. It isn’t always mandatory for the government to engage in deficit spending (the federal deficit increased from 5.4 percent in 2022 to 6.3 percent in 2023). Governments have flexibility in their financing strategies, and issuing bonds is just one of several options. Regardless, that is not always discussed in the mainstream media (no surprise there!).
We can control U.S. debt by cutting spending, growing the economy, and reducing the debt-to-GDP ratio. However, this would mean introducing policies that foster innovation, productivity, and job creation. The U.S. government can also lower rates, making U.S. debt loads more manageable.
We also need to focus on reverting to the mean and stop the habit of getting into perpetual debt, but this is probably just wishful thinking. Needless to say, 2024, and subsequent years, will be very interesting. How much will the next presidential administration spend?
