The Debt Spiral

A debt spiral is a dilemma in which a government, company, or person takes on more and more debt, seemingly without limit. Typically, an entity suffering a debt spiral will take on debt to service interest payments on older debt. Such a strategy could work if the entity discovers novel revenue streams. On the other hand, such a strategy could fail if interest rates rise and the entity is forced to default.

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The debt spiral of a government has many stages. First, debt levels rise. This could be because of overspending, unexpectedly low tax revenue, or emergencies that required unplanned government intervention.

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After the public notices that the government has taken on increasing amounts of debt, markets begin to pierce the government’s new financial status into its collective decision-making. With respect to bonds, people are now only willing to buy them if they offer greater returns than they had before the government went steeper into debt. In short, increasing government financial insecurity pressures interest rates to rise in tandem.

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As going into debt becomes more expensive for the government, their expenditures increase as well. Here we see the seeds of what could be a debt spiral.

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At this point, a government could cut spending and/or raise taxes. In theory, this could work to reverse the debt spiral. In practice, it is typically unpopular either to cut government programs or raise taxes. In democracies, politicians rightly regard such solutions as a political death sentence.

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The longer governments fall into a debt spiral, the more likely is an eventual default, if only because eventually, no one is willing to purchase their debt. With the advent of central banking, this stop-gap has been overcome, as banks can ‘just’ purchase debt from their governments. To be sure, there are constraints even central banks’ ability to purchase government debt. Perhaps more importantly, the voting public will eventually lose patience with the devaluation of their currency. Governments, in the end, are at least constrained by public opinion.

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Debt spirals are not hypothetical constructions. The United States may be suffering through one right now. In the last few decades, the U.S. government ‘got away’ with increasing levels of debt because of low interest rates. In other words, it has been quite cheap for the government to borrow money. However, 2022 saw interest rates finally rising, signaling that the debt-fueled honeymoon phase may be ending.

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Recent projections indicate that interest payments on government debt may triple from just under $400 billion to $1.19 trillion sooner than had been anticipated. 

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A little over one year ago, a 10-year Treasury bill offered an interest rate of 1.5%. As of December 2022, it rose to 3.7%. 

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As reported in The Boston Globe, “Interest costs as a percentage of the nation’s total economic output will double to 3.3 percent by 2032, and more than double again to 7.2 percent in the two decades after that...That would be the highest since the government began tracking the data in 1940 and top the total spending on Social Security anticipated in 2052.”

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As more resources are diverted towards covering rising interest payments on the debt, the government is less able to pay for other services that its citizens enjoy. Perhaps that is both the way forward and a silver lining: the United States government will auction off its products and services to the private sector in order to pay off its debts. By the time the government is no longer in debt, it will be a shadow of its former self, having sold off most of its parts to the rest of society. In such a world, the government barely performs any services at all, and it never again goes into debt.

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Bitcoin helps to bring make such a fantastical future into a reality, but that is another story.

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