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  <h2 class="vjs-social-description">Andrew Wang is the cofounder and CEO of online mortgage servicing company Valon.</h2>
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WILL HIGH GOVERNMENT DEBT CREATE PROBLEMS AS RATES RISE?

Simon Moore
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Will elevated debt to GDP create problems for the U.S. government as interest
rates rise? ... [+] Photographer: Sarah Silbiger/Bloomberg

© 2022 Bloomberg Finance LP

Interest rates have shot up this year, and the Fed is expected to hike rates
even more. This is unlikely to impact the U.S. government debt in the near term,
but may present an issue over the coming years if interest rates remain
elevated.




If rates were to remain at around current levels, it would ultimately cause more
government expenditure to go to paying interest on the national debt. That
additional interest cost could amount to double what the government spends on
veterans, or half the U.S. defense budget.



The recent U.K. experience has demonstrated the risks when markets start to lose
confidence in the fiscal position of a government. This is also a relatively
broad issue. Many developed economies including Canada and much of Europe have
high debt to GDP today and are seeing rising interest rates in the current
market.



PROMOTED




RECENT TRENDS IN DEBT TO GDP

Since the financial crisis in 2008 U.S. government debt to gross domestic
product (GDP) has approximately doubled from 63% to 121%. However, over that
same period interest rates declined relatively steadily.




This meant that even though the U.S. had more debt over recent decades, the
interest cost on the debt compared to GDP has been broadly flat. Lower interest
rates largely offset the higher debt.

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RISING INTEREST COSTS

Now that may be changing. Interest rates have broadly returned to where they
were before 2008 and government debt compared to GDP has doubled since then.
This won’t cause the borrowing costs of the U.S. government to rise immediately.
That’s because the weighted average duration of U.S. debt is between five and
six years. This means that U.S. government debt won’t reprice to market interest
rates overnight, but government interest costs could steadily rise over this
decade.



For example current interest rates on U.S. government debt are around two
percent on average for 2022. If that level of interest rates doubled to four
percent, which is a reasonable reflection of where U.S. government debt trades
in the secondary market today, then that would be a significant addition to
government spending.

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A doubling of expenditure on interest, would add a cost roughly equal to half
the Medicare budget. That’s manageable, but not trivial.

Also the Fed plans to raise rates further, illustratively if interest rates were
to hit six percent then spending on interest on the national debt could
ultimately rival Social Security spending, the largest single item of government
spending. The markets currently expect the Fed to stop raising rates well before
six percent is hit and are unsure that we’ll even see five percent rates at the
short end of the curve, but it shows that if the Fed fights inflation too
aggressively it may present issues for management of the federal budget.


HISTORICAL PRECEDENT

However, a doubling of interest cost compared to GDP would not be unprecedented.
In the early 1990s interest cost was around three percent of GDP, or double
current levels. Also, debt to GDP in the U.S. has declined slightly since the
pandemic from a high of 135%. Currently high inflation may bring the ratio down
further as inflation means GDP is growing faster than the debt, as the value of
the national debt is largely fixed in nominal terms.

Still this may become an issue for markets over the coming years if interest
rates remain at current relatively high levels compared to recent history.

Of course, we may be close to the top of the current interest rate cycle,
meaning this issue may fade if interest rates fall as inflation recedes, but if
interest rates do continue to rise in 2023, then this issue topic become more
relevant to many western governments and those that invest in their national
debt.


Follow me on Twitter or LinkedIn. Check out my website or some of my other
work here. 
Simon Moore
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Simon provides an outsourced Chief Investment Officer service to institutional
investors. He has previously served as Chief Investment Officer at Moola and
FutureAdvisor,

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Andrew Wang On Breaking Into The Mortgage Business
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SHARE: ANDREW WANG ON BREAKING INTO THE MORTGAGE BUSINESS


ANDREW WANG IS THE COFOUNDER AND CEO OF ONLINE MORTGAGE SERVICING COMPANY VALON.

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