Exploding budget deficits have put the U.S. government debt burden on pace to surpass GDP by 2012, according to International Monetary Fund forecasts.
The debt total hit a record high of $13 trillion this month, and gross domestic product, or GDP, stood at $14.6 trillion in the first quarter.
That’s bad news for both the economy and the Treasury bond market.
“Economic historians such as Kenneth Rogoff point out that at debt levels of 80 to 90 percent of GDP, a country’s real growth becomes stunted,” Bill Gross, who manages the world’s biggest bond fund for Pimco, wrote in his June outlook on the firm’s website.
Our spiraling debt, of course, makes the United States dependent on foreign investors to finance it.
“Over the long term, interest rates on government debt will likely have to rise to attract investors,” Hiroki Shimazu, an economist at Nikko Cordial Securities, told Bloomberg.
“That will be a big burden on the government and the people.”
The prospect for rising rates is turning many investors bearish on the Treasury market.
Dan Fuss, who manages the top performing Loomis Sayles Bond Fund, has sold all of his Treasury holdings out of concern that the massive debt buildup will send rates soaring.
“The fundamentals are awful,” he told Bloomberg.
“The incremental borrower of funds in the U.S. capital markets is rapidly becoming the U.S. Treasury. Do you really want to buy the debt of the biggest issuer?”
For now, U.S. markets aren’t suffering anything more than heightened volatility and a mild decline in stocks.
But that could change in a hurry.
“The burden of debt can take decades to accumulate, but only a few short months to change course into crisis,” Gross wrote.
“Many investors, economists and politicians alike have little understanding of why attitudes and lending standards can reverse so quickly – how a seemingly innocuous buildup of debt will suddenly produce a crisis.”
The prevailing attitude is that markets, jobs and economies will eventually come back, Gross says. “Sometimes it doesn’t come back. Sometimes nothing turns up.”
It’s not just government debt either, he notes. Household and corporate debt have exploded as well.
“Common sense observation tells you that the debt super cycle trend in the U.S. is reaching unsustainable proportions and that the growth required to service it, if real interest rates were ever to go up instead of down, would be insufficient,” Gross maintains.
“That is why lenders balked 18 months ago during events surrounding the Lehman liquidity crisis, and why they’re beginning to balk once again.”
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