Hard facts suggest that
interest rates
for longer-duration debt instruments, especially sovereign debt, will fall this year.
First off, too many countries have a high level of
government indebtedness
. The net government debt is so high in many countries that as interest rates rise, the economic cost to service that debt becomes intolerable. Financing the debt crowds out necessary investment and becomes ever more burdensome. A negative feedback loop is created. When government uses tax dollars to fund deficits, those tax dollars are not available for activities that promote long-term growth. High levels of government
debt reduce economic growth
.
The U.S., Japan, and Italy are three countries burdened with very high levels of government debt. In addition, the private sector in all three countries has taken on debt. Many economists
predict a recession
, but recession or not, economic activity will slow. Some private companies will find it difficult to service their debt. Bankruptcies will increase. The Federal Open Market Committee, FOMC, continues to tighten monetary policy. The Bank of Japan and the European Central Bank are tightening monetary policy, and as monetary policy is tightened across the globe, the risk of financial contagion increases.
Other problems abound.
Japan’s population is falling, and that limits GDP growth. Japan’s government debt is already 260% of its GDP. Every 1% increase in interest rates in Japan thus raises the cost of servicing Japan’s government debt by 2.6% of its GDP. The private sector in Japan also has substantial debt, and Japan’s central bank is reaching the limits of its ability to tighten monetary policy. A pivot to looser policy is an increasing possibility.
Italy is also burdened with excessive government debt. Only the backstop of a guarantee by the European Central Bank prevents Italy from being at risk of defaulting on its sovereign debt. Yet Europe
could easily revisit
the debt crisis of 2009-2010. Given large government borrowing by Germany and France to limit exploding energy costs and to mitigate the negative economic effects of the war in Ukraine, the European Central Bank backstop effectively guaranteeing the sovereign debt of Italy and Greece is becoming less certain. Skepticism that the European Central Bank can maintain tight monetary policy and continue to backstop the government debt of other countries in Europe is, therefore, warranted.
The U.S. is also approaching the point where interest rates cannot go higher. The net federal debt is almost 100% of GDP. At the moment, high inflation is shielding the economy from the negative effects of that level of net indebtedness. Because of elevated inflation, nominal GDP is growing faster than the increase in the net federal debt. Soon, economic growth will slow, and it may, in fact, contract. Slower economic growth coupled with still elevated inflation and the inexorable rise of demographically driven entitlements obligations will cause the net federal debt to GDP ratio to climb. Necessary government spending and private sector investment will be crowded out. Long-run productivity growth will fall, and the federal government will be forced to borrow more and more to service the debt.
The central banks of Japan, Europe, and the U.S. are aware of the risk of a global financial doom loop. As that risk increases, the possibility of global financial contagion also rises. To emphasize, skepticism about continued global monetary tightening across the globe is warranted.
CLICK HERE TO READ MORE FROM RESTORING AMERICA
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes
a daily note
on finance and the economy, politics, sociology, and criminal justice.
