How an Interest Rate Hike Will Affect the Government of USA

The stock market is already worried about high-interest rates in the forthcoming year. The fact that interest rates will rise in 2018 is a foregone conclusion. The debate is whether Fed will hike the rate three times in the year or will there be even more rate hikes. The common opinion on Wall Street is that the trend is changing. The extended period wherein interest rates were kept artificially low is now over. The increase in interest rates marks the beginning of a trend wherein the rates will continue to go higher for the next few years. This will have a deep impact on the American economy as well as several other economies across the world. However, one of the biggest effects will be on the American government itself. In this article, we will have a closer look at how interest rate hikes will impact the working of the United States Treasury.

Increasing Yields

At the present moment, the yields on Treasury bonds are at historic lows. The ten year Treasury bond will now yield more than 3% after almost a decade of low-interest rates. However, economists believe that the rise in the interest rates will be sharp this time. The Federal Reserve has to ensure that the economy does not face excessive inflation. Hence, the rates may rise steeply to 4% within 2018. Over the next five years, the rise in interest rates is expected to be even more dramatic. The long-term average of interest rates on treasury bonds is 5%. It is likely that the yields will return to 5% in the next few years. In simpler words, the cost of interest is likely to double as the government will start paying 5% on their bonds. It also needs to be understood that on average treasury bonds tend to get refinanced every five years. Hence, in the next five years, the government will be liable to pay interest on bonds which have been refinanced at a higher rate.

The Increase in Outstanding Debt

President Obama’s economic policies have wreaked havoc on America’s fiscal situation. Before, President Obama took office in 2009 America owed a total of $12.3 trillion to the world. At the present moment, this stands at a mammoth $20 trillion. However, critics argue that the American government owes some of this money to itself. Hence, if we look at only external debt, this figure has increased from $7 trillion to $14 trillion during the eight-year tenure of President Obama. Now, it is likely to reach $17.5 trillion by the year 2020.

Hence, the amount owed to outsiders has increased by leaps and bounds. If the interest rate also doubles, America will be facing a full-fledged debt crisis. Since Obama had kept the interest rates so low, the interest payments on the debt went from $190 billion to $250 billion even though the debt more than doubled. However, after the interest rate resets, this debt is likely to cross $850 billion.

This number is staggering, to say the least. The reason is that America spends less than this number on their military budget and they have one of the largest arsenals in the world. Also, America spends less than this on their social security schemes. Hence, if no action is taken, it is likely that interest payments on debt outstanding will become the biggest expense for the American government. At the present moment, the American government collects about $1.6 trillion in personal income taxes. This means that 50% of all income taxes will have to be paid as interest!

This could be the real reason that the government is not raising interest rates rapidly. Inflation may not be as politically unpopular as raising taxes to pay more interest. However, the period of low-interest rates has been stretched for too long and from here on the rates will only rise.

Trump and the Rate Hike

Many critics are of the opinion that Donald Trump will not raise the interest rates. This is because he was a real estate developer. All his businesses are likely to suffer massive losses if he raises interest rates too soon. Hence, many call him the ultimate “loose money President”

This may not be the reality as the current scenario will force the government to raise interest rates. The options will be a steep drop in prices because of high-interest rate or a destruction of the economy caused by hyperinflation. Zero interest rate policies are not natural. This is the first time in the history of the world, that interest rates have been suppressed for so long. It will be interesting to see how they return to normal.

To sum it up, private companies are not the only ones who have something to lose when the interest rates rise. The United States government will be the biggest loser. It is likely that the government has been delaying the inevitable because of this reason.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.


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