Latest / The National Debt Podcast with Fexingo: Treasury, Borrowing, and Long-Term Fiscal Outlook / The Silent Tax of Rising Debt Service Costs
Transcript
- Lucas: If walking through the economy with us has made something click, or if you’ve found our deep dives into these complex fiscal mechanics genuinely useful, know that this show runs on listener support. A couple of dollars a month is what keeps these recordings ad-free and allows us to keep digging into the data without advertisers looking over our shoulders. If you want to help us keep doing that, you can find us at buy me a coffee dot com slash fexingo. Luna: Thanks for supporting the work. Now, let’s get back to the numbers that are keeping so many economists up at night right now. Lucas: Right. So, we need to talk about the silent killer of modern fiscal policy: debt service. We’ve been tracking the ten-year Treasury yield, which as of mid-September is hovering around four point nine five percent. That might not sound catastrophic compared to the double-digit spikes of the early nineties, but context is everything here. The total federal debt has crossed thirty-nine trillion dollars, and when you combine that massive principal with sustained higher rates, the annual interest bill isn't just growing; it's accelerating. Luna: It’s the compounding effect that scares me. We aren't just paying more on old debt; we’re issuing new debt at significantly higher coupons than we were even eighteen months ago. Lucas: Exactly. And the market is pricing this in aggressively. Look at the three-month Treasury yield, which touched four percent recently, and the thirty-year yield pushing past five point three five percent. This isn't a temporary blip caused by one bad inflation report. The curve is steepening in ways that suggest investors are demanding a premium for holding US debt over the long haul. We saw the thirty-year yield jump from five point two eight to five point three seven in just a few days last week. That volatility signals deep structural concern. Luna: So when you say debt service, you mean the actual cash outflow the Treasury has to make to bondholders? Because that money is gone forever. It doesn't build infrastructure or fund education. Lucas: Precisely. And here is the concrete detail most people miss: interest payments are now competing directly with discretionary spending. In previous quarters, we saw the deficit narrow slightly, dropping from negative one point eight one trillion to negative one point seven seven trillion by late September. But that narrowing was driven by revenue fluctuations and temporary factors, not a fundamental reduction in borrowing costs. Meanwhile, the debt to gdp ratio ticked up to twelve point six percent. The gap between what we earn and what we owe is being eaten away by the interest tab. Luna: That’s a terrifying dynamic. You have a government that is effectively borrowing more just to pay interest on what it already owes. Is that accurate? Lucas: That is the definition of a fiscal feedback loop. When debt service consumes a larger share of federal revenue, you lose flexibility. Let’s look at the Federal Reserve Funds rate, which has remained flat at three point six three percent. While the Fed holds short-term rates steady, the long end of the curve—the ten-year and thirty-year—has run hot. This divergence forces the Treasury to rely heavily on shorter-term bills to roll over debt, exposing them to refinancing risk every ninety days or so. If those short-term rates spike, the cost of servicing the entire portfolio jumps immediately. Luna: But don't foreign buyers still hold a huge chunk of this? I read headlines about them exiting, but isn't the domestic demand absorbing most of the supply? Lucas: The headline about foreign buyers exiting is real, though nuanced. Foreign official holders have been trimming positions, likely due to currency management and geopolitical diversification. That leaves domestic institutions—pension funds, mutual funds, and individual investors—to pick up the slack. But here is the catch: domestic investors are also facing higher inflation. With consumer prices persisting above target and wage growth lagging, households are feeling the pinch. If retail demand for Treasuries weakens because people are prioritizing daily expenses over savings instruments, the Treasury has to offer even higher yields to attract capital. It becomes a vicious cycle. Luna: So the very thing that makes bonds attractive—higher yields—is eroding the pool of buyers who can afford to invest in them. That’s a brutal paradox. Lucas: It is. And consider the opportunity cost. Every billion dollars spent on interest is a billion dollars not spent on defense, healthcare, or R&D. We are seeing the crowding-out effect in real time. The Congressional Budget Office and various private analysts are projecting that net interest costs could surpass defense spending within the next decade if yields remain at these levels. That would be a historic inversion of federal priorities. Luna: Defense spending is already massive. If interest beats that, we are essentially running a military-industrial complex for bondholders. Lucas: A dark way to put it, but economically sound. The question is, why does the market tolerate this? Why are investors buying forty-year or thirty-year bonds at five point three five percent when they could arguably lock in safer assets elsewhere? The answer lies in the lack of alternatives. Global sovereign debt is similarly bloated. Europe, Japan, China—all are dealing with high debt burdens. The US dollar remains the reserve currency, so there is a 'devil you know' premium attached to Treasuries. But that premium is shrinking. The spread between the ten-year and the two-year has compressed to just thirty-three basis points. That flattening suggests the market expects either lower growth or a potential Fed pivot soon. Luna: Or they expect inflation to stick around, forcing the Fed to keep rates higher for longer. Which do you think it is? Sticky inflation or a recessionary pivot? Lucas: Given the recent CPI data showing inflation persisted in August despite some cooling in core services, I lean toward sticky inflation. The labor market is resilient, but wages aren't keeping pace with the cost of living. That squeezes consumers, reduces demand, but doesn't necessarily crash the economy immediately. Instead, it creates a stagflationary pressure where growth is slow, but prices stay elevated. For the Treasury, this is the worst-case scenario because it prevents both the inflation-driven erosion of debt value and the deflationary collapse that might force emergency monetary intervention. Luna: So we are stuck in the middle. High rates hurt the borrower, low rates hurt the lender, and stagnation hurts everyone. How does the Treasury manage this without defaulting or printing money? Lucas: They manage it through maturity management. The Treasury is trying to lengthen the average duration of its debt issuance. By locking in longer-term rates now, even if they are higher, they avoid having to refinance trillions of dollars in maturing bills over the next few years. It’s like refinancing a mortgage when you still have credit available. They are using the window of current liquidity to secure stability, even at a higher cost. But it’s a stopgap, not a solution. Luna: It feels like we are delaying the inevitable reckoning. If political will doesn't address the root cause—spending vs. revenue—then the interest burden just becomes an unavoidable tax on future generations. Lucas: That is the crux of it. Fiscal policy is political, but the bond market is mechanical. The market doesn't care about your ideology; it cares about your solvency. If the trajectory of debt to gdp continues upward while yields remain structurally higher than the nominal GDP growth rate, the math simply doesn't work without austerity or inflation. We are seeing the early stages of that adjustment. The fact that the Dow and S&P 500 are volatile today reflects investor anxiety about where this ends. Luna: Do you think there’s a tipping point where foreign central banks decide to dump Treasuries en masse, causing yields to spike uncontrollably? Lucas: A disorderly exit is unlikely because there is nowhere else to go. The Eurozone bond market is fragmented, and Chinese holdings are already diversified into gold and commodities. However, a gradual reduction in demand is already happening. This puts upward pressure on yields, which acts as a form of implicit taxation on the US government. It’s a soft squeeze rather than a hard crash. But over a decade, that soft squeeze can hollow out public capacity. Luna: So the lesson here is that debt isn't free money anymore. It’s a liability that demands respect and payment, and the price of that payment is rising. Lucas: Exactly. And for businesses, this translates to higher cost of capital. If the risk-free rate is five percent, corporate borrowing becomes significantly more expensive. This slows down expansion, hiring, and innovation. The ripple effects of sovereign debt service extend far beyond Washington D.C. They touch every balance sheet in the country. Luna: I wonder if we’ll see more political rhetoric focused on 'financial repression'—pressuring banks to hold Treasuries—to keep yields down artificially? Lucas: That’s a possibility. Regulators could impose stricter liquidity requirements that favor government securities. It’s a subtle form of coercion that doesn’t require legislation. But markets are smart. If they sense artificial suppression, they’ll find ways to hedge against it, often through derivatives or alternative assets. The pressure will always find an outlet. Luna: For listeners watching their portfolios, what’s the practical takeaway? Should they be avoiding bonds entirely? Lucas: No, but they should be selective. Short-duration treasuries are yielding well and offer liquidity. Long-duration bonds carry significant interest rate risk if yields move higher again. Diversification is key. Real assets, equities with strong cash flows, and maybe some inflation-protected securities. But remember, the baseline assumption for the next few years is that borrowing costs will remain elevated relative to the last decade. Luna: Elevated costs change the game. It shifts the advantage from borrowers to savers, at least nominally. But as we discussed, savers are squeezed by inflation too. Lucas: Which brings us back to the real metric: real returns. If inflation is three percent and a bond yields four point five percent, your real return is only one point five percent. That’s barely enough to preserve purchasing power, let alone grow wealth. The era of easy, high real returns on safe assets is over. Luna: It’s a sobering reality check. We have to work harder for every percentage point of gain now. Lucas: Absolutely. And that discipline applies to governments too. Just like individuals, if you spend more than you earn, you eventually face the consequences. The US is currently in the phase where the consequences are manageable but mounting. The question is whether we act before they become critical. Luna: Do you think we have the political bandwidth to make the tough cuts required to lower the deficit, or are we too polarized? Lucas: Polarization makes fiscal discipline nearly impossible. Both parties tend to resist cutting popular programs or raising taxes. So we rely on growth. If the economy expands faster than debt accumulates, the problem solves itself. But with productivity growth slowing and demographic headwinds hitting Social Security and Medicare, relying on growth alone is risky. Luna: So we are betting on technology and innovation to save us from our own fiscal mismanagement. Is that a good bet? Lucas: It’s the only bet we have. AI, energy transition, biotech—these sectors promise efficiency gains that could boost GDP. But they take time to materialize at scale. In the meantime, the interest bill keeps ticking up. It’s a race between innovation and indebtedness. Luna: A fascinating and tense race. One where the finish line keeps moving further away. Lucas: That’s the best way to describe it. As we wrap up, I’d love to hear your thoughts on how you’re adjusting your personal finances in response to these higher rates. Are you locking in long-term debt now, or waiting for a dip? Luna: Great question for the comments section. Until then, keep an eye on those Treasury yields—they tell the story of where we’re headed. Lucas: Thanks for listening. We’ll be back tomorrow with another deep dive into the mechanics of the global economy.