Ryan Kimmel, an Analyst on DoubleLine Capital’s Macro Asset Allocation team, conducts a thought experiment. Assuming federal fiscal deficits running at their post-GFC average and a range of interest rate scenarios, the U.S. economy could collapse under the weight of the federal debt within 10 years. In this video presentation, recorded Nov. 14, 2023, Mr. Kimmel reprises part of an Oct. 3 presentation delivered by DoubleLine CEO Jeffrey Gundlach at the fall Grant’s Investment Conference in New York.
Mr. Kimmel begins with a review (0:13) of negative credit rating news on the creditworthiness of the U.S. government and evidence that the market is having difficulty absorbing the surge of securities issuance by the Treasury Department to fund the federal deficit. He then summarizes (1:09) “Mr. Gundlach’s base case: that we're entering a secular period of rising rates” that could lift “the interest burden for the U.S. government, which turns into a self-reinforcing environment of higher interest rates, feeding into higher deficits, which feeds into higher debt loads.”
As the starting point for a prospective “debt spiral” (1:56), Mr. Kimmel notes that by one estimate the U.S. government is running a primary deficit equaling 6.3% of GDP, the highest level outside the Global Financial Crisis (GFC) and the COVID-19 economic lockdown. In fact, after certain accounting adjustments by the Congressional Budget Office (CBO), the actual deficit-to-GDP ratio might be 7½% in fiscal year 2023. Sustained federal deficits have fed into ever-higher levels of debt loads, with the debt-to-GDP ratio now just below 100%. With after years of funding its debt with near-zero interest rates, the U.S. now is refinancing into higher-rate debt (4:40). Interest expense risks growing into a serious threat to America’s fiscal condition.
CBO projections for the next 10 years, which also assume no recessions, assume an average interest rate on the national debt near 3%. What if, as DoubleLine expects, the U.S. has entered a secular period of high interest rates? Mr. Kimmel runs 10-year forward scenarios (6:24) of interest-rate expense assumed under the CBO projection as well as 3%, 6% and 9% rates. By 2027, as more low-rate debt is rolled into Treasuries at higher rates, the effect of those terminal rates is showing up, especially under the 6% and 9% interest expense assumptions. Those effects are measured in terms of interest expense consuming a greater share of tax revenue (7:16) that otherwise would go to domestic and defense spending, and progressive increases in the budget deficit (8:05) and size of the debt as a share of GDP (9:02).
The CBO also assumes deficits averaging 3% over the next 10 years. Mr. Kimmel runs outcomes of the four interest rate scenarios assuming primary deficits of 5% (the post-GFC average), into 2033. This results in more rapid fiscal deterioration as measured by interest expense as a percentage of tax revenue (9:40), budget deficit as a percentage of GDP (10:43) and the federal debt as a share of GPD (11:17). For example, assuming a 5% primary deficit, the federal debt in 2033 at 6% interest expense equal 170% of GDP and at 9% interest expense would equal 210% of GDP.
“Higher interest rates will feed through into higher and higher debt loads,” Mr. Kimmel summarizes (11:54). “And those higher debt loads could eventually crowd out private capital formation. And in response to the higher interest burden, the government will have to increase taxes and reduce government spending, which combined are negative for economic activity going forward. You get to a point where at some point the debt loads become so high that the economy collapses on itself under the weight of its own debt.”
At what point would such a debt spiral enter this end game? Mr. Kimmel points to recent research by the University of Pennsylvania Wharton Budget Model project. The “point of no return,” according to the Penn Wharton Budget Model, lies somewhere between 175% to 200% debt to GDP.
