Column-‘War economy’ angle on debts risks ‘creative’ solutions: Mike Dolan By Reuters

By Mike Dolan

LONDON (Reuters) – Big public debts typically stem from big economic and political junctures that require government to spend big – but reining them back risks ‘creative’ solutions markets may struggle to price.

The cumulative cost of post-pandemic public spending amid new geopolitical realities – including anything from green energy investment, chip-making security or Ukraine-related defence bills for example – are now getting plotted into years ahead of outsize government deficits and debt projections.

The uncomfortable question of debt sustainability is top of mind again for many in financial markets.

Although an issue across the Western world, much of the sound and fury about mounting debts centres on the United States – and for good reason.

The Congressional Budget Office projects a 17 percentage point jump in the U.S. public debt-to-GDP ratio over the next 10 years to 116% – twice the average level of the past 20 years – and then rising even further to 166% by 2054.

Describing it as a ‘non-controversial’ statement, Federal Reserve Chair Jerome Powell on Tuesday said U.S. fiscal policy was on an ‘unsustainable path’.

While that may be stating the obvious, it’s a bald statement from the most powerful public servant presiding over the rising cost of that debt pile.

And this is where the whole issue risks looping.

Having hit a record low in April 2021, the average interest cost on the U.S. public debt has more than doubled since then to 3.23% – the highest in 14 years – as the Fed has hiked interest rates to contain the post-pandemic inflation spike.

The persistence of brisk growth and above-target inflation despite that monetary tightening is, for many economists, at least partly down to the demand stimulus created by those unchecked deficits. And it argues, in turn, for tighter Fed policy than many had hoped.

And even though the CBO’s long-term debt projections are explosive, they are based unnervingly on relatively modest expectations for borrowing costs ahead – with the average debt servicing cost only getting back above the 20-year average of 3.7% in 2054.

The problem comes from the debt accumulated in the interim and the fact the CBO can’t see a ‘primary’ budget gap that excludes interest costs returning back below 2.0% of GDP – also the average of the 1994-2023 period – for the next 30 years.

What’s more, total debt servicing costs start to…