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Global government debt levels have been
growing rapidly over the last 25 years and
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are now forecast to exceed $100 trillion dollars
by the end of this year. For developed countries,
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the average ratio of public debt to GDP is
back to where it was in 1945 – when public
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debt rose above 100% of GDP after two
world wars and the Great Depression.
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The recent surge in borrowing was driven by a
series of shocks, first the global financial
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crisis, then the pandemic and then the Russian
invasion of Ukraine. For most of that period
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interest rates were low and falling, but, since
the Pandemic, we have seen a spike in inflation
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globally, which pushed interest rates up,
meaning that any new debt being issued is
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much more expensive – but that has – in no way
stopped governments from borrowing and spending.
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A quick glance at the news shows that even
as rates are rising budget deficits around
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the world are projected to grow. Government
spending in most countries has been high since
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the pandemic for a few reasons. For one thing,
politicians tend to spend a lot more in election
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years and 2024 was the biggest election year in
world history where 72 countries that encompass
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half of the world’s population held elections.
Governments spent a lot to win reelection – and
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newly elected leaders are now spending a
lot to fulfill their campaign promises.
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So, what is the money being spent on?
Globally there has been a lot of climate
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change spending– which is expected to continue
or possibly increase and in Europe we saw high
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government spending to shield consumers from a
spike in gas prices. Geopolitical tensions all
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around the world mean that military spending
is expected to grow in the coming years too.
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Last year, government spending around the
world was the highest it has ever been
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outside of a crisis – with the biggest
driver of increased spending being the
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rising interest rates on government debts.
This week, the U.S. Treasury Department saw
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soft demand at a $16 billion dollar 20-year bond
auction, which caused stocks and the dollar sell
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off while Treasury yields rose. According to
Reuters the weak auction shows intensified
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investor worries about the ballooning US debt
which could spur bond market vigilantes who
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want more fiscal restraint from Washington.
This came after Moody's downgraded the US
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government's credit rating, citing
the growing debt and little progress
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toward resolving it. The move was not a huge
surprise as Moody's was the last of the big
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three rating agencies to take the step and had
warned two years ago that this might happen.
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The 30-year US treasury yield rose above
5% earlier this week and has stayed there.
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In Japan, events were even more dramatic when
the weakest demand seen at a government debt
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auction in more than a decade drove the 20-year
government bond yield up to the highest rate in
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twenty-five years. The yield on 30-year Japanese
Government bonds climbed to the highest level
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seen since that maturity was first sold in
1999 – so an all-time record. Yields on the
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40-year Japanese Government bond rose to a record
high too - of 3.7%, which is a full percentage
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point higher than at the start of April.
As the FT points out – a sharp move like that from
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such a low starting point means that investors
who owned that bond have lost almost 20 percent of
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their investment in just a few weeks. To
highlight how ugly the Japanese government
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bond market is right now – we have to look at the
less liquid bonds – which investors are keeping
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well away from – for fear of being stuck in a
difficult to sell bond as prices collapse.
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The Japanese yield curve is not just upward
sloping — it is the steepest upward sloping yield
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curve in the developed world. This means that
longer maturity bonds pay higher interest rates.
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But, in the market chaos the 35-year bond (which
was issued as a 40 year bond five years ago) now
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yields over 100 basis points more than the 40-year
bond, (this makes no sense in such a steep upward
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sloping yield curve) but the reason this is
happening is that the 35 year bond is a lot
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less liquid than the more recently issued 40 year
bond – it's what’s known as an “off the run” bond.
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And it’s trading at a surprisingly higher yield
because investors are so afraid of buying a bond
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that might be difficult to sell. The FT describes
this as pretty stark evidence of the evaporating
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demand for longer-term Japanese debt.
This kind of drama in high-grade – developed
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market government bonds - where bonds are supposed
to be the safe asset class is an example of how
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things can go wrong when investors back away
from lending to highly indebted nations.
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Japan – today has the highest public debt-to-GDP
ratio in the world at over 240%. This ratio
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was only at around 50% of GDP in 1990. Over
the same period the US has gone from a debt
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to GDP ratio of around 40% to 100% today. So
why have governments around the world become
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addicted to debt – and can they deleverage?
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The surge in Japan’s debt to GDP ratio over the
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last thirty-five years was driven by a combination
of huge government spending aimed at reviving a
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stalled economy, combined with a collapse in GDP
growth. So, debt grew and grew, while GDP didn’t.
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Over that period there have been huge stimulus
packages, including infrastructure spending
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and social welfare spending, all in an attempt
to end persistent deflation and low growth.
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Japan’s rapidly aging – and hyper aged -
population is part of the problem too as
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retirees demanded spending on healthcare and
pensions, significantly adding to the debt
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burden. The growing debt never caused a real
problem over that period simply because the
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government was borrowing at such low interest
rates. The problem is that when interest rates
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start to rise, Japan has to either stop borrowing
and start paying down its debt - or its massive
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borrowing will become unmanageable.
Japan’s prime minister told parliament
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this week that he disagrees with the idea
of funding tax cuts with bond issuance,
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signaling caution over new government spending now
that the nation’s borrowing costs are rising. The
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surge in Japanese Bond yields highlights the
concerns of bond investors globally about the
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risks of unsustainable government spending.
These higher yields in Japan are part of a
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global trend, where government borrowing
costs in the world’s largest economies
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are rising as investors question the ability of
governments to cover massive budget deficits.
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The yield on the UK's 30-year government
bond spiked as high as 5.54% this week,
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up 40 basis points year-to-date.
The UK is expected to post a budget
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deficit equivalent to $185.5 billion dollars
this year – which is slightly lower than last
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year's levels. They expect the budget to remain
in a deficit through the end of the decade.
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Chinas debt to GDP has been growing
over the last 15 years and is expected
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to continue growing as the country runs
deficits to stimulate the slowing economy.
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China has for decades aimed to keep the official
deficit at no more than 3% of GDP but has breached
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that figure three times since 2020. The government
set this year’s fiscal deficit target 4% of GDP.
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The US hit its debt to GDP record in late 1945,
when US national debt was briefly larger than the
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entire US economy. After a three-decade decline,
by the mid 1970’s debt had fallen to around a
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quarter the size of the economy. Since then it has
been steadily growing, under both Democratic and
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Republican presidents. It really took off in the
wake of the global financial crisis where it hit
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around 75% of GDP and again in early 2020 when the
pandemic struck, it soared close to 100% of GDP.
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When you look at the chart you can see that
debt has generally grown during time of war
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or financial crisis - when unemployment
is high, and economic growth is low.
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Overall, the US has the eighth highest
public debt to GDP ratio in the world.
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Right before the pandemic, the US economy was
in its longest expansion in modern history,
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but, at the same time, US debt was - quite high
and growing – which was unusual at the time as
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normally that deep into an economic
expansion – you would expect to see
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budget deficits shrinking – but the US budget
deficit was instead growing – and at a faster
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and faster rate even before the pandemic hit.
In April 2020, - the federal government delayed
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tax payments, meaning that money stopped
coming in and the treasury announced that it
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would borrow three trillion dollars in the second
quarter alone. Who would buy all this debt? Well,
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the Federal Reserve was the biggest buyer –
it expanded its treasury holdings by nearly
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two trillion dollars in a matter of two
months. That month Americans received
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their first stimulus checks in the mail.
The Congressional Budget Office (a nonpartisan
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federal agency whose role is to provide congress
with objective analyses and estimates related to
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economic and budgetary decisions) is now
predicting that Americas debt-to-GDP ratio
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will rise from 98 percent where it is today to
a record 125 per cent in the next decade. There
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is no war or recession right now to easily explain
the rapidly increasing pace of borrowing – and the
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US unemployment rate is near an all-time low.
Because the US government has been spending
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more than it collects in taxes
since the global financial crisis,
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the national debt has been growing. Even without
President Trumps planned deficit spending – as
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part of his budget – the US debt to GDP ratio is
expected to exceed the 1945 high in nine years.
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If Trump’s One Big Beautiful Bill
act makes it through the Senate,
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The Committee for a Responsible Federal Budget,
a nonpartisan group that favors debt reduction,
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estimates that US national debt will
reach 129 percent of GDP by 2034.
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Now, on the campaign trail – Trump claimed
that he would not be running a massive budget
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deficit – he instead said that he would
balance the budget. [Donald Trump Clip] [I
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Want to do what has not been done in
24 years – Balance the Federal budget]
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Trump’s team claim that the legislation,
when combined with his pro-growth policies,
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will halve the US fiscal deficit from
its current level of 6.4 percent,
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to 3 percent by the end of his term.
His Council of Economic Advisers claims
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the bill will boost real economic growth by
up to 5.2 per cent over the next four years,
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creating (or saving) up to 7.4 million
jobs and raising investment by up to
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14.5 percent over the next four years.
Not everyone agrees with that,
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while many agree that the tax cuts might boost
economic growth, they argue that the increased
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borrowing and the inflationary effect of trumps
trade policies will drive up interest rates on
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government bonds while slowing the US economy.
The Center for American Progress, a liberal
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research group, have published projections which
assume that all of the bill’s temporary provisions
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get permanently extended. They say that in such a
scenario government debt could reach about double
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the size of the economy by 2055, compared with 156
percent without any changes to the existing law.
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The weak US Treasury auction this Wednesday
highlighted investor fears over Americas
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rising debt burden. In the lead-up to the
vote on Trump’s Big Beautiful Bill in the
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House of Representatives, the 30-year
Treasury yield rose to 5.1 per cent, as
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the price of the bonds fell. It extended its
rise to 5.12 per cent after the bill passed
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the House of Representatives by a single vote.
The recent debt downgrade by Moody’s has also been
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putting upward pressure on US interest rates.
So, if every government is borrowing, who is
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buying all of these government bonds? Well,
Pension funds are amongst the biggest buyers
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of government bonds because they are considered a
safe investment. Investment funds, central banks,
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other governments, and individual investors also
buy bonds. According to the US Treasury, 80% of
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US government bonds are held by Americans and 20%
by other governments. When we look at a breakdown
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of that 80% - we can see that almost a quarter is
held by the Federal Reserve, with the rest held
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by mutual funds, state and local governments,
pension funds, insurance companies and banks.
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So, what does the US government spend all that
money on? Well, the federal budget is divided
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between mandatory spending, discretionary
spending and interest payments on the debt.
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More than 60% of the budget goes toward
mandatory spending, which is automatic
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unless Congress changes the legislation
authorizing it. Social Security, Medicare,
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and Medicaid make up 75% of mandatory spending.
About 28% goes towards discretionary spending,
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which Congress has to authorize each
year through the appropriations process.
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About half of the discretionary spending goes to
defense-related agencies and programs. The rest
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is spent on things like health, education,
veterans’ benefits, and transportation.
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About 12% of the budget goes on interest
payments on the national debt. As you can
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see this has risen over time as both the scale of
borrowing and interest rates have gone up. This
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is projected to continue rising in the future.
Interest payments were $880 billion dollars last
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year which is more than was spent on Medicare
and the military. The financial historian Niall
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Ferguson told the FT that “Any great power
that spends more on debt servicing than on
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defense risks ceasing to be a great power.”
Unless debt is paid down that $880 billion dollar
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“interest expense” can be expected to grow as most
of the borrowing was done when interest rates were
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much lower than they are today – and when the US
still had a AAA credit rating. Even if the amount
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borrowed stayed the same – as old bonds expire
and are replaced with new bonds – the interest
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rate on those new bonds will be higher than the
interest rate was on the bonds that expired.
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While nonpartisan research groups are
estimating that Trump’s budget will
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add more than $2.5 trillion dollars to
the federal debt over the next decade,
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White House Press Secretary Karoline Leavitt
says that the Budget will actually save the
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federal government $1.6 trillion dollars. She said
“This bill does not add to the deficit. It is the
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largest savings for any legislation that has ever
passed Capitol Hill in our nation’s history.”
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The $1.6 trillion dollar figure – seems
to refer to the spending cuts in the bill,
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but it ignores the fact that the government will
still be spending significantly more overall than
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it brings in in taxes – which means borrowing at
whatever the prevailing interest rate is. In their
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downgrade announcement - Moody’s predicted that
the US budget deficit would rise from 6.4 per cent
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last year to just under 9 per cent by 2035.
So, is the Trump Administration right that
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the new budget will spark growth, and
that the US can outgrow the deficit?
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Well, during the global financial crisis, the
US treasury issued huge amounts of new debt, a
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lot of which was bought up by the Federal Reserve
– a lot like what happened during the pandemic.
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Some economists predicted huge inflation at
the time, and businesses being crowded out of
00:19:12
the debt market, but that didn’t actually occur.
Economists then started rethinking many of their
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theories around how much borrowing is too much.
In 2019, Olivier Blanchard – an MIT professor
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and the former chief economist at the IMF
used his last speech as president of the
00:19:32
American Economic Association to put forward
a provocative idea: In a world where interest
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rates are very low – he said - governments
can afford to take on a lot more debt.
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In a speech titled Public Debt and Low Interest
Rates, Blanchard laid out the theory that as
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long as the interest rate on government debt is
lower than the growth rate of the economy - that
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governments can tolerate a lot more borrowing than
had previously seemed reasonable. He argued that
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big government debts may not be as dangerous
as they were previously believed to be.
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Trumps bet is that he can grow the US economy
faster than he grows the national debt, and that
00:20:16
way he can move towards a balanced budget.
The worry is that his whipsaw approach to
00:20:22
trade policy — which has included massive
tariff announcements followed by delays,
00:20:28
exemptions and reversals — has undercut
businesses’ ability to plan and invest.
00:20:34
This Friday, just hours before trade
talks were scheduled to start with the EU,
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Trump threatened a 50% tariff on EU goods
while also warning Apple that he would
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impose a 25% import tax "at least" on iPhones not
manufactured in The United States, later widening
00:20:54
the threat to any smartphone being imported.
On Trumps liberation day in April, he announced
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a 20% tariff on most EU goods, then halved it to
10% for 90 days to allow time for negotiations.
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It is not obvious how huge tariffs and constantly
changing trade policies would boost US economic
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growth. There is a real risk that these policies
are inflationary and kill economic growth – which
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would mean higher interest rates on the debt than
the current 5% rate – with no offsetting growth.
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Bond investors who lock up their money at a
fixed rate hate inflation, as it eats into their
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returns. They equally hate if the currency
the bonds are denominated in depreciates.
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The term "bond vigilante" was coined by the
economist Ed Yardeni in the 1980s. He used
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the term in a letter to describe investors who
reacted to government policies, particularly those
00:21:57
perceived as inflationary or excessive spending,
by either selling off bonds they owned – which
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drove up yields – or by just declining to buy
them. The idea was that politicians can’t mess
00:22:10
with the bond market and that when politicians
get out of line the bond market reminds them
00:22:16
of the need for fiscal responsibility.
In the UK, Liz Truss's proposed mini-budget
00:22:23
was quickly abandoned a few years ago when the
bond market reacted badly to its announcement
00:22:29
and in the early 90’s the ten-year bond yield
rose from 5% to over 8% in what was known as
00:22:36
the "Great Bond Massacre” over concerns
about federal spending. Clinton political
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adviser James Carville remarked at the time
that he” would like to come back as the bond
00:22:47
market as you can then intimidate everybody."
Robert Armstrong made a very good point in his
00:22:53
Unhedged newsletter a few weeks ago about Trumps
plan to onshore manufacturing. Where if a big
00:23:00
chunk of human, financial and physical capital
is to be deployed in manufacturing and exports,
00:23:06
they have to be redeployed away from what they
are currently doing. And it is very possible that
00:23:12
redeployment to manufacturing and exports will
make that capital less productive. After all,
00:23:19
there is a reason that this capital is not
deployed in manufacturing today. And less
00:23:24
productive use of capital in the United States
means the country gets poorer, not richer.
00:23:31
Another difficulty that the US will face in
trying to grow its way out of high debt is
00:23:36
that its ageing population and low birth rate
means that the working age population is in
00:23:42
decline and without immigration there will be no
one to work in all of the factories that Trumps
00:23:48
tariffs are supposed to bring back onshore.
Despite the claims that Elon Musk would be
00:23:53
able to slash two trillion dollars of wasteful
government spending by eliminating waste, fraud,
00:23:59
and abuse. The DOGE website is now only claiming
$170 billion dollars in savings, much of which has
00:24:07
been disputed as many of the contracts that DOGE
claimed to have cancelled, had either already been
00:24:13
cancelled or would never have cost as much as
DOGE are claiming. Research from the BBC could
00:24:19
only verify 32.5 billion dollars from the wall
of receipts – which – at less than 2% of what
00:24:26
was promised - doesn’t do much to balance the
budget. According to CBS there are offsetting
00:24:33
costs of $135 billion dollars when you add up
the cost of rehiring mistakenly fired workers,
00:24:40
defending lawsuits, layoff packages and so on.
Reductions in government spending can be
00:24:46
factchecked by going to the Treasury Department
website where they publish US government monthly
00:24:52
spending data broken down by agency and program.
Despite the big claims, total federal spending is
00:25:00
about 7% higher over the last two months than it
was during the same months a year ago – so no cost
00:25:07
cutting has showed up in the data so far.
Most of the research I can find shows that
00:25:14
Governments only cut spending in response to a
crisis, and the problem with that is that these
00:25:19
forced spending cuts can be indiscriminate and
make a financial crisis worse. The problem is that
00:25:26
politicians love borrowing and spending because
the paying back comes in somebody else’s term.
00:25:33
Since the turn of the millennium interest rates
started out low and fell lower – and during that
00:25:39
period of declining interest rates governments
have grown addicted to borrowing and spending
00:25:44
which they got away with because the low interest
rates meant that economies could out grow the
00:25:50
interest rate on the debt. With US 30-year rates
above 5% and anti-growth policies being pitched by
00:25:57
politicians this becomes a lot more difficult.
Trumps tariffs could of course cause problems in
00:26:04
other countries too. According to JP Morgan
research - The impact of the trade war will
00:26:10
be focused on the U.S. but the rest of the world
will not be immune to the damage. They say that
00:26:17
the trade war could reduce global GDP by
1%. In a world with such elevated levels
00:26:23
of government debt – lower growth can only
be expected to make the situation worse.
00:26:29
In its October Fiscal Monitor report, the IMF
warned about the enormous surge in public debt
00:26:36
over the last five years, with the global debt
to GDP ratio now 10 percentage points above its
00:26:42
level on the eve of the pandemic. Their research
showed: countries with debt that was not expected
00:26:49
to stabilize accounted for more than half of
global debt and about two-thirds of world GDP.
00:26:56
The UK, Brazil, France, Italy and South
Africa were among the countries where
00:27:02
debt was expected to continue rising.
They said that “in countries where debt
00:27:08
is projected to increase further, delaying
action will make the required adjustment
00:27:13
even larger” and they called for “cumulative
fiscal adjustment” — tax rises or spending
00:27:20
cuts — of 3 per cent to 4.5 per cent of
GDP to bring down debt across the world.
00:27:27
They added that government spending to fund the
transition to greener energy together with ageing
00:27:33
populations and security concerns were likely to
add to fiscal pressures over the coming years.
00:27:39
Governments may wish to inflate away the debt in
the coming years where they allow high inflation
00:27:46
to reduce the real value of their outstanding
debts. But higher inflation as we have seen in
00:27:51
recent years is very unpopular and can lead
to governments being thrown out of office.
00:27:57
If you found this video interesting, you should
watch this one next. Don’t forget to check out our
00:28:03
sponsor Flexispot using the link in the video
description. See you in the next video, bye.
