Morne Patterson — How US Debt Will Lead to Long-Term Devaluation of the Dollar
The growing US debt has become a significant concern for economists, investors, and policymakers alike. As US debt continues to rise, there are mounting concerns about its long-term effects on the value of the US dollar. This issue has far-reaching implications for the global economy, as the US dollar serves as the world’s primary reserve currency and plays a central role in international trade and finance.
The relationship between US debt and the dollar’s value is complex. It involves various factors such as interest rates, GDP growth, and the issuance of government bonds. This article will explore how the accumulation of US debt might lead to a long-term devaluation of the dollar, examine the drivers behind the debt increase, and look at projections for the future of the US currency. We’ll also consider the potential consequences for both domestic and international markets.
Factors Driving US Debt Accumulation
The accumulation of US debt has become a significant concern, with the national debt currently exceeding $35 trillion. This staggering figure has doubled over the past 15 years, highlighting the severity of the issue. Several factors contribute to this growing debt, including government spending patterns, tax revenue shortfalls, and interest payments on existing debt.
Government spending patterns
The US government’s spending habits have played a major role in the accumulation of debt. Federal spending has been driven by rising healthcare costs, demographics, and interest payments on the national debt. These factors, combined with insufficient revenues, have created a structural mismatch between the government’s income and its expenditures.
One of the primary drivers of long-term fiscal challenges is the inefficient healthcare system. As the population ages, more Americans qualify for federal healthcare programmes. Older individuals generally require more healthcare, which puts additional strain on the federal budget. Healthcare spending is projected to rise faster than inflation, wages, and the overall economy, creating enormous challenges for the US economy and federal government.
The ageing population has also had an impact on Social Security spending. Over the next 25 years, the number of people aged 65 or older will increase much faster than the working-age population. In fact, the number of individuals aged 85 and older is expected to almost triple from 2024 to 2054. While increased longevity is positive, it means the government will spend more on programmes serving older Americans.
Tax revenue shortfalls
The US tax system does not generate enough revenue to cover the promised spending levels. The tax code is overly complex, confusing, inefficient, and unfair. It contains numerous tax expenditures or “tax breaks” that provide financial benefits to specific activities, entities, and groups of people. These tax breaks, which totalled $1.8 trillion in 2023, increase annual deficits and can create market distortions that are damaging to economic growth and productivity.
During economic downturns, government borrowing typically rises due to reduced tax revenue and higher outlays on social safety net programmes.
Interest payments on existing debt
As the national debt grows, so does the cost of servicing that debt. Interest costs are the fastest-growing “programme” in the federal budget, exceeding the growth of Social Security and Medicare.
The recent upturn in interest rates has made financing government debt more expensive. As of April 30, 2024, the average interest rate for all federal government-issued interest-bearing debt had jumped to 3.23%. This increase in interest rates has magnified the issue related to growing US federal government debt.
The proportion of the federal budget required to maintain the national debt has grown significantly. In February, the CBO projected that annual net interest costs would total $870 billion in 2024 and almost double over the upcoming decade, rising from $951 billion in 2025 to $1.6 trillion in 2034.
These ballooning interest costs threaten to crowd out important public investments that can fuel economic growth in the future. By 2054, interest costs are projected to be nearly three times what the federal government has historically spent on R&D, non-defense infrastructure, and education combined.
The Relationship Between National Debt and Currency Value
The relationship between national debt and currency value has been a subject of intense scrutiny in economic circles. This complex interplay has significant implications for a country’s economic stability and its position in the global financial landscape.
Historical examples
Throughout history, there have been instances where national debt has influenced currency value. In 2001, the United States experienced a notable increase in its net debt to the rest of the world, reaching $2.3 trillion, which was double the amount recorded in 1999. This surge was partly due to new borrowing to finance the mounting current account deficit. Interestingly, a third of this change was attributed to an accounting effect related to the rising dollar’s impact on the value of U.S. assets held abroad.
The Cold War era provides another historical perspective on the relationship between debt and currency value. Both Western and Eastern bloc countries accumulated massive debt during this period. However, the nature of this debt differed significantly. The United States financed its Cold War efforts by borrowing against the future, which allowed for some social spending while constraining it. In contrast, Eastern bloc countries took shortcuts in their financing, which ultimately affected their economic stability.
Market perceptions
Market perceptions play an important role in the relationship between national debt and currency value. If markets begin to question the credibility of a country’s sovereign debt, it could lead to currency depreciation and excess inflation. For instance, the United Kingdom faced a “mini” fiscal crisis in 2022, resulting in a 10% depreciation of the pound.
The accumulation of new liabilities by a country due to persistent current account deficits can be a significant cause for concern. As a nation’s debt to foreign countries grows, investors may become increasingly reluctant to lend additional funds. This situation might compel the country to reduce its current account deficit through slower growth or a depreciation of its currency.
However, it’s important to note that changes in the net international investment position resulting from valuation effects are relatively less worrisome. Asset prices and exchange rates are more volatile than real variables like GDP, meaning that the net international investment position can be quickly stabilised or reduced through price movements, with little adverse impact on growth.
Long-term Projections for the US Dollar
The long-term outlook for the US dollar is a subject of intense debate among economists, policymakers, and investors. Several factors, including Federal Reserve policies, global economic trends, and potential scenarios for dollar devaluation, play crucial roles in shaping the future of the world’s primary reserve currency.
Federal Reserve Policies
The Federal Reserve’s monetary policy decisions have a significant impact on the dollar’s value and its role in the global economy. The Fed’s recent actions, particularly in response to economic crises, have raised concerns about the dollar’s long-term stability.
The Fed’s unprecedented monetary expansion, implemented to address the 2008 crisis and the financial impact of COVID, has led to a substantial increase in its balance sheet. This expansion, achieved through quantitative easing (buying of large assets) and reduced interest rates, has prompted worries about potential inflation and currency debasement.
As of April 30, 2024, the average interest rate for all federal government-issued interest-bearing debt has jumped to 3.23%. This upturn in interest rates has magnified the issue related to growing US federal government debt.
Global Economic Trends
Several global economic trends are influencing the dollar’s future prospects:
1. Shifting reserve currency composition: Recent data from the IMF indicates a gradual decline in the dollar’s share of allocated foreign reserves of central banks and governments.
2. Rise of non-traditional reserve currencies: The reduced role of the US dollar over the last two decades has been accompanied by an increase in the share of non-traditional reserve currencies, including the Australian dollar, Canadian dollar, and Nordic currencies.
3. Growing economic weight of emerging markets: Emerging markets are expected to increase their share of the world economy from around 44% to 56% by 2050, potentially giving their policymakers more influence on global trade and financial flows.
4. Geopolitical tensions: Continued geopolitical tensions could threaten the dollar’s dominance.
Potential Scenarios for Dollar Devaluation
Several scenarios could potentially lead to dollar devaluation:
1. Persistent fiscal imbalances: If the US continues to run large budget deficits (currently just over 6% of GDP) and trade deficits (about 3% of GDP), it could erode confidence in the dollar.
2. Loss of reserve currency status: While unlikely in the short term, a gradual shift away from the dollar as the primary reserve currency could undermine its value. The euro and the Chinese renminbi are potential challengers, though they currently lag far behind the dollar in global usage.
3. Geopolitical shifts: The ongoing Russia-Ukraine crisis and US sanctions on Russia have made some countries wary about being too dependent on the dollar. This could accelerate de-dollarisation efforts, particularly among non-aligned countries and China’s trading partners.
4. US policy missteps: A technical default triggered by a failure to renegotiate the US debt ceiling or a significant degradation of US institutions could weaken the dollar’s position and open the door for other currencies to gain a more dominant position.
While these scenarios present potential risks to the dollar’s value, it’s important to note that the US currency’s global dominance is deeply entrenched. The dollar’s role in international trade, finance, and as a store of value gives it considerable resilience. However, the long-term trajectory of the US dollar will depend on how effectively policymakers navigate these challenges and maintain the currency’s credibility in the global financial system.
Conclusion
The growing US debt and its potential impact on the dollar’s value have far-reaching consequences for the global economy. As the debt continues to rise, driven by factors such as government spending patterns, tax revenue shortfalls, and mounting interest payments, the long-term stability of the US currency faces increasing uncertainty. The Federal Reserve’s policies, coupled with shifting global economic trends, have an influence on the dollar’s future prospects and its role as the world’s primary reserve currency.
To wrap up, while the US dollar’s global dominance remains deeply entrenched, the challenges posed by persistent fiscal imbalances, geopolitical shifts, and potential policy missteps cannot be ignored. The long-term trajectory of the US dollar will depend on how effectively policymakers navigate these challenges and maintain the currency’s credibility in the global financial system. As the situation evolves, it’s essential for investors, policymakers, and global economic players to keep a close eye on these developments and their potential implications.
FAQs
What are the consequences of excessive debt in the U.S.?Excessive debt in the U.S. can lead to a reduction in business investment and a slowdown in economic growth. It can also trigger expectations of rising inflation and diminish confidence in the U.S. dollar. It’s crucial for the federal government to manage budget imbalances to avoid damaging the economy and affecting families nationwide.
What factors could lead to a depreciation of the U.S. dollar?The U.S. dollar could depreciate due to several economic influences such as changes in monetary policy, increasing inflation, fluctuations in currency demand, variations in economic growth rates, and shifts in export prices.
What are the long-term consequences of U.S. national debt?Long-term, if investors start doubting the U.S. government’s ability to manage its debt, they might demand higher interest rates, which would increase borrowing costs for businesses and households. This could lead to decreased confidence, reduced investment, and slower growth in productivity and wages for American workers.
What are the implications of a devalued U.S. dollar?A devalued U.S. dollar can lead to an inflationary spiral by making imports more costly, which exacerbates already high inflation rates. Even with aggressive interest rate hikes by the U.S. Federal Reserve to control inflation, the impact might be minimal. Additionally, domestic businesses may struggle to afford materials and retain staff due to the scarcity of dollars.
