US Sovereign Debt Levels, Is The US Deficit The Next Financial Crises?

US SOVEREIGN DEBT
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Introduction
In 2009, the US sovereign federal debt was $9.1 trillion. At the end of 2018, the debt was at 21 trillion, and it is expected to hit $30 trillion by the year 2025 CITATION Luo18 \l 1033 (Xuan, 2018). At that level, the interest rates might be so high that the government cannot cover them from fiscal revenue. At the moment, the interest rates have surpassed many other mandatory programs and soon they the American government will spend more on the interest of the debt than what it spends on the military. For all of fiscal 2018, net interest on the public debt rose by $62 billion to about $371 billion CITATION Rac181 \l 1033 (Layne, 2018). In the next decade, the interest on the debt is likely to hit $7 trillion CITATION Rac181 \l 1033 (Layne, 2018). The level of the US debt is raising concerns among many economists citing that it is fast approaching unsustainable levels and many pointing out that it could spark the next financial meltdown. The US economy is robust, but the trajectory of the debt points to the likelihood of the US inability to repay it and the interest earned on the principal. If the US is unable to repay the loan or the interests earned, the economy can tumble. At the moment the debt is racing to unsustainable levels and economists have raised concerns over the economic and diplomatic issues it could cause should it become unpayable. They have also pointed out many effects of the ballooning debt especially on the economy. The political class has either and or ignored these warnings have done little to tame the debt. Some economists argue that the debt is likely to lead to the next financial crisis though others think it is not a problem.
The national debt is mainly classified into two; intergovernmental debt and public debt. Intergovernmental debt is the debt owed to federal agencies such as Social Security Trust Fund whilst the public debt is owed to the public, i.e., people and agencies outside the federal government such as individuals, corporations, the Federal Reserve System, and foreign, state and local governments. The debt can also be classified into external and internal debt using local (domestic) and foreign criterion. External debt is owed to foreign investors (governments, foreign corporations, individuals from other countries) across the world. Internal debt is owed to the citizens of the United States either through government agencies such as Social Security Trust Fund or through private investment channels such as hedge funds.
Who is it owed to?
As of December 2018, when the sovereign debt totaled $21.9 trillion, $5.9 trillion was an intergovernmental debt which accounts for 27 percent of the debt. About 230 federal agencies own the debt and earn interest on it. Federal agencies like the Social Securities Trust Fund are the main owners of the debt. Through their revenues, they buy the government’s treasuries. Other federal agencies like Medicare, military retirement funds also own various percentages of the national debt. Some individual investors through either directly or through hedge funds and other financial institutions also own a piece of the national debt. Other institutions which own a piece of the national debt are the FED and commercial banks. Individuals, banks hold about 12% of the debt whilst the FED owns about 12 %. Mutual funds own about 9% and state and local governments own 5%. Foreign investors and governments cumulatively own about 30% of the debt. The main foreign investors are China and Japan. China is the largest foreign investor with $1.14 trillion of US debt and Japan with $1.023 trillion. Other governments with large percentage ownership are Brazil with $314 billion, Ireland with $287 billion, the United Kingdom with $274 billion and Luxembourg with $225 billion. Other countries like Cayman Islands, Belgium, Hong Kong, Saudi Arabia, Taiwan, India Switzerland among others also have sizeable stakes in the debt.
US Debt Versus the GDP
One of the best ways to determine the risk level of debt is by comparing it to the GDP. This is a good comparison metric because it shows the state of the economy and shows the likeability or lack of thereof of the sustainability of the debt. If the GDP grows fast enough to outpace the debt growth, then the size of the debt is not a big problem since it shows the economy can comfortably contain the debts effects. However, if the debt grows faster than the GDP, it means it will reach a point where it will be higher than that the GDP and the government will default on its payments. Recently, Sri Lanka defaulted on its debt with China, and she had to bequeath their port to China for 99 years. Thus, defaulting on debt can have catastrophic effects on the economy and sovereignty of a nation. At the moment, Greece has been grappling with the effects of its debt which have adversely affected the economy by leading to high unemployment levels and slumping economy. Hypothetically even before that point the country will have had challenges to meet its payment obligations of the debt especially on the interest earned on the debt. Thus, the increasing levels of the US debt are not as healthy as the percentage of debt to GDP has been increasing. According to the US Bureau of Public Debt, ‘debt-to-GDP ratio of 104.17 percent in 2015 and 105.4 percent in 2017’ CITATION Wil18 \l 1033 (Kenton, 2018). Though this is not the highest GDP-Debt ratio of the US government in history, it is inching to unstainable levels. The GDP-debt ratio was 31.7 in 1974, and it has been growing steadily since then. Since the increase of GDP-debt ratio and high GDP-debt ratio indicates the country’s inability to repay its debts and hence the likelihood of default, lenders charge a higher interest rate to governments which borrow. Thus, with the apparent unsustainability of the US debt, the mounting debts will be more expensive and hence compound the challenge of repaying the loan.
Why the Debt Can Cause a Financial Crisis
Recently, as with the case of Greece where unemployment hit 25%, and youth unemployment is at 50% caused by national debt, it shows debts have the catastrophic ability on the economy should they become unsustainable. The US could also find itself in a similar position if preemptive measures are not taken. A huge public debt affects the government’s ability to respond to economic issues faster to stimulate recovery. In the wake of the 2008 financial crisis, the government turned to the FED to borrow and stimulate economic recovery. The FED through the purchase of treasury bills injected nearly $2 trillion into the economy and the economic machine rejuvenated. At the time, the public debt was about $10 trillion, and the government could afford to borrow more. However, in the case of the high debt the government has today, it is unlikely that the government would turn to borrow to stimulate the economy. The debt-GDP ratio is nearly 77% which is the tipping point for creditors to reconsider and review interest rates upwards according to the World Bank. Concisely, a broke and debt-ridden government might not be able to borrow to stimulate economic recovery even on small issues that can send shocks through the economy such as natural disasters and belligerence. The economy is at a precarious stage as demonstrated by the stock markets which hit a new low since the 2008 financial crisis indicating that the US might experience a recession. Recession compounded by high interest rates and the unlikelihood of the bailout because of the high debt can affect the economy and cause it to spiral down to the financial crisis. Simple issues can spark unprecedented shock to the economy, i.e.; a natural disaster can slow the economy which would affect the government’s ability to repay its debt.
The level of US debt is also scaring investors especially foreign entities who own a piece of it. China, the largest single foreign investor in US Treasuries, has threatened to dump and or stop purchasing more treasuries citing the level of the debt CITATION Wol18 \l 1033 (Richter, 2018). China and other investors have raised concerns over the US government ability to repay the loan. Additionally, the escalating trade war that has emerged during Trump’s presidency can prompt China to dump its treasuries. This would wreak havoc on the US economy as the supply of US bonds would be high. Fixed income prices would fall, and yields would rise and creditors in the economy especially the US companies and consumers would be unable to borrow hence slowing the economy. It would also be more expensive for the US government to issue debt and certainly the interest rates would be increased. If such a move id adopted by China, it may prompt other government to do the same and start dumping its US treasuries. Since nearly 40% of US debt is foreign owned, th...