How Long Can the Federal Reserve Continue to Push Interest Rates Up Before the Federal Government Goes Bust?

Recently, Howard Wang of Convoy Investments wrote the article “US Debt-Servicing Costs Skyrocket: $1.4 Trillion in Interest Payments on Deck”. (https://www.zerohedge.com/markets/us-debt-servicing-costs-skyrocket-14-trillion-interest-payments-deck).  In the article, Mr. Wang noted that if the current ~4.5% average interest rate propagates to all $31 trillion in federal government debt, interest payments on that debt will balloon to $1.4 Trillion.

As shown in the graph below, interest payments have risen to nearly $750 billion. The trajectory doesn’t look good.

Source: https://fred.stlouisfed.org/series/A091RC1Q027SBEA

How long it takes for interest rates to be fully reflected in federal government interest payments depends on the composition of federal debt with regard to term length. Short-term debt turns over quickly and the newly reissued debt will have a higher interest rate than the retired debt. Thus, short-term debt turnover translates relatively quickly to higher interest payments, whereas the longer-term debt takes more time. Federal debt is composed of the following debt types:

Back when the debt was about $22 trillion in 2020, Catherine Austin Fitts and I divided federal debt by term length to calculate the required annual turnover:

The shorter-term debt is turned over quickly, which is a major driver of rising federal interest payments right now. The longer-term debt can be a driver too, but the timing depends on when that debt was issued.  On the books, the largest portion of internally held debt is the Social Security Trust Fund (~2.85 trillion). However, a meaningful portion of internally held obligations is short-term debt which turns over every single business day! Note that non-marketable securities are largely composed of internally held debt, which is managed by the US Department of Treasury. At the time, we did not realize that a significant portion of non-marketable debt is reissued daily, generating far more than the estimated $102 trillion in annual turnover shown in the table above. See Skidmore, Torrejon, and Pare (2022) (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3849862) for details on why nonmarketable internally held debt generated more than $100 trillion in redemptions and reissuance in 2020.

If the Federal Reserve keeps pushing interest rates up, eventually interest payments will blow out the federal budget.  I think Wang’s calculation is generally correct; when the ~4.5% interest rate is fully reflected in federal government interest payments, expenditure on interest will increase from ~$750 billion to ~$1.4 trillion. The steep trajectory on federal government interest payments is driven by deficits to some degree but mainly from rising interest rates in combination with debt turnover.

Below, I provide a forecast of federal revenues for 2023 (not including borrowing):

It is important to recognize that SST revenues are earmarked and thus are not supposed to be used for purposes other than to fund Social Security.  Holding federal revenues constant, if interest payments rise to $1.4 trillion, those interest payments will be ~33% of federal revenue and ~48% of federal revenue net of SST.  If interest rates rise to ~5.5%, interest payments will eventually increase to ~$1.7 trillion (~36% of federal revenue and ~55% of federal revenue net of SST).  Pushing rates to ~6.5% ultimately generates interest payments of $2 trillion (~43% of federal revenue and ~65% of federal revenue net of SST). 

These “back of the envelope” calculations are very rough, but they provide a road map with the coming brick wall in clear view.  Something has to give: Either the Federal Reserve will reverse course, or the currently urgent federal debt issue quickly becomes a national/global crisis.