With the close of the U.S. Treasury’s fiscal year on September 30, 2023, there came an important update (provided by the Heritage Foundation) on the U.S. Treasury budget for the prior fiscal year. A brief summary of the update is as follows: the U.S. budget expenditure for the fiscal year was $ 6.1 trillion, the total tax revenue collected was $4.4 trillion, U.S. Treasury borrowing (the deficit) was $ 1.7 trillion, and the interest expense on all outstanding U.S. Treasury debt came in at $879 billion. These numbers reveal some very significant and alarming realities.
As Treasury market rates rise in a desperate attempt to attract buyers for Treasury debt, the interest expense on the U.S. national debt will explode.
For starters, $1 trillion equals $ 1,000 billion; thus, the interest expense noted above is just $121 billion short of the $1 trillion mark. At the current level of Treasury interest rates (over 5 percent for short-dated Treasury securities), coupled with conservative current 2023-24 deficit projection that assumes no recession ($2 trillion) and an outstanding debt roll of roughly $8 trillion over the next 12 months, the interest expense on all outstanding U.S. Treasury debt will clear the $1 trillion mark ($1,000 billion) before the end of the Treasury’s fiscal year ending September 30, 2024. On average, interest expense for the U.S. Treasury will exceed $80 billion per month. However, that expense could easily ramp up to well over $100 billion, or significantly more, in the immediate months ahead. (READ MORE: Are Deficits Actually Going Down?)
Many observers of the Treasury financial situation might say “so far so good,” meaning that the country can handle it. To date, that assessment might seem accurate, given that the U.S. Treasury has been able to issue new debt and roll the old debt. However, what’s looming dead ahead — likely in the next three to six months — is a significant slowdown in the U.S. economy. That slowdown has been expected all year, and has been elusive. Unemployment has remained low and the stock market has held up, although off the highs of earlier this year. At the same time, inflation and high interest rates have slowly diminished consumer purchasing power. The net effect of inflation and high interest rates will be a recession. The only question is whether it will be a soft landing or a hard landing. History says a hard one. The talk of a soft landing always attaches itself to the beginning of an economic slowdown. It very rarely happens. Although this time ramped up defense spending for two proxy wars might cushion the descent.
What is for sure, however, is that a hard landing and/or ramped up defense spending will gap out the U.S. Treasury deficit. A recession coupled with ramped up defense spending could easily get the deficit over $4 trillion. So what does a $4-trillion deficit mean for the U.S. economy?
The most important thing to recognize is that the U.S. Federal Reserve will become securely captured by the U.S. federal budget and the attended budget deficits. The term that economists use for this is “fiscal dominance.” There will be no other sufficient source of funding for a $4-trillion federal deficit other than the Fed’s printing press attached to its balance sheet. The miracle of mouse-click fiat money will eventually be fully employed. The result will be a knee-jerk reaction in the Treasury bond market. It will follow a pattern like this:
As the looming recession becomes visible, interest rates will fall as they traditionally do. Then the knee-jerk reaction will occur. Treasury bond market participants will see the magic of mouse-click fiat money employed by the Federal Reserve and interest rates will rise.
Why will interest rates rise? The answer to that question is that there will come a time when no one (other than the Federal Reserve) will want to buy U.S. Treasury debt. Mouse-click fiat money will be completely recognized for what it is, an accounting gimmick with zero intrinsic value. As Treasury market rates rise in a desperate attempt to attract buyers for Treasury debt, the interest expense on the U.S. national debt will explode. That explosion in cost will force the U.S. Treasury to issue additional debt in order to pay the interest expense on existing debt. That in turn will force the Federal Reserve to directly or indirectly buy the Treasury’s debt to prevent a national bankruptcy (fiscal dominance).
While all the above is unfolding in the Treasury bond market, the U.S. dollar will probably be in free fall at the same time. Foreign investors will exit the U.S. Treasury bond market and the U.S. stock market en masse, converting their U.S. dollars back to their home currencies. (READ MORE: Biden’s Upside-Down Economy)
If all of this were not bad enough, the forced money printing to cover federal deficits will drive inflation dramatically higher. Perhaps not a hyperinflation like the 1922-23 Weimar Germany experience where the currency was totally destroyed, but more like a U.S. version of Argentina’s current inflation. Argentina is currently suffering from an annual inflation rate of over 120 percent and a currency that has collapsed from about 45 pesos per U.S. dollar four years ago to more than 350 pesos per U.S. dollar currently.
Bottom line, fiscal dominance and Argentina’s current economic experience is somewhere in our future, sooner or later.