Latest / The National Debt Podcast with Fexingo: Treasury, Borrowing, and Long-Term Fiscal Outlook / The Real Cost Of Borrowing In A High Debt Era
Transcript
- Lucas: If walking through the economy with us has made something click, remember that this show runs on listener support. It keeps the research sharp and the ads off. If you want to help keep these conversations going, head over to buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. Luna: Yeah, and just a quick reminder that even small contributions make a real difference in keeping the production quality high. Lucas: Thanks. Now, let’s get back into the weeds. We’ve been talking about the sheer size of the federal debt for years, but today I want to zoom in on a specific mechanical shift that most people miss: the changing composition of who is actually buying our debt. Luna: You mean domestic versus foreign holders? Because that narrative gets recycled every time there’s a geopolitical spat. Lucas: It’s more granular than that. Look at the latest data from late September. The federal deficit for that quarter hit negative one point nine nine trillion dollars. That is a massive jump from the previous quarter’s deficit. But here is the thing that worries me more than the headline number: interest payments on that debt are now consuming a larger slice of every dollar the government collects. Luna: So it’s not just about the principal anymore; it’s about the servicing cost eating into other budget items? Lucas: Exactly. And because the ten-year Treasury yield is sitting at five point zero five percent as of yesterday, the cost of refinancing that debt is higher than it was two years ago. When you combine a rising deficit with sticky-high interest rates, you create a feedback loop. You borrow more to pay interest, which pushes yields up slightly, which makes the next round of borrowing even more expensive. Luna: That sounds like a classic debt spiral, but isn’t the US dollar’s reserve status supposed to buffer us against that? Lucas: It does buffer us, but buffers have limits. Let’s look at the ten-year yield again. It ticked up to five point zero five percent on October twenty-eighth. Meanwhile, the three-month Treasury yield dropped to four point one eight percent. That spread tells us the market is pricing in slower growth ahead, yet they still demand a premium for holding long-duration US debt. Luna: So investors are saying, 'We know growth is slowing, but we’re still worried about inflation or supply risks.' Is that fair? Lucas: Precisely. And here is where it hits your wallet directly. Those Treasury yields act as the baseline risk-free rate for the entire economy. If the ten-year note is at five percent, your mortgage rate, your auto loan, and corporate bond spreads all sit on top of that floor. The third-quarter GDP came in at a strong three point four percent, which surprised everyone, but that growth didn’t lower borrowing costs. Luna: Right, because the Fed funds rate is still around three point seven five percent, and the market knows inflation is sticky. So the low-rate era is definitely over. Lucas: Over for now. But consider the debt to gdp ratio. It’s currently at one hundred twenty-one point two percent. It dipped slightly from one hundred twenty-two point four percent earlier in the year, but that’s a marginal improvement. The total federal debt is approaching thirty-nine point five trillion dollars. At these interest rates, the annual interest expense is climbing toward levels we haven’t seen since the early nineties. Luna: Which means less money for infrastructure, defense, or social programs unless taxes go up or spending goes down drastically. Both politically toxic. Lucas: Both politically toxic. So what happens? We see a phenomenon called 'financial repression' or just passive monetization. The Federal Reserve holds a lot of Treasuries already. With the interest on reserve balances sitting at three point nine zero percent, the Fed is effectively paying banks to hold cash. But when the Fed lets its balance sheet roll off, it stops buying new debt, leaving private markets to absorb the issuance. Luna: And private markets, like pension funds and insurance companies, are price-sensitive. They aren’t going to just absorb trillions in new supply without demanding higher yields. Lucas: Correct. And that’s why we saw the thirty-year Treasury yield climb to five point three seven percent recently. Long-end yields are sensitive to fiscal sustainability concerns. If investors doubt the government’s ability to control the deficit, they demand a term premium. That term premium is essentially a tax on future growth. Luna: It’s interesting you mention pensions. For a lot of retirees, their income is tied to fixed-income investments. Does this environment hurt them specifically? Lucas: It’s a double-edged sword. On one hand, higher yields mean better income for new money flowing into bonds. But if they’re locked into older, lower-yielding assets, their purchasing power erodes if inflation stays above two percent. The European Central Bank kept rates on hold at two point five percent yesterday, showing they’re cautious too. Global central banks are all trying to find the soft landing while managing their own sovereign debt issues. Luna: So it’s not just a US problem. Europe is dealing with similar fiscal constraints, and Japan is struggling with its own yield curve control adjustments. It’s a global liquidity crunch. Lucas: Exactly. And when global liquidity tightens, capital flows become more volatile. We might see emerging markets suffer first, but then it ripples back to US municipal bonds. Local governments are also borrowing at these elevated rates to fund schools and roads. That could lead to service cuts or local tax hikes, which affects property values and local economies. Luna: I hadn’t thought about the municipal angle. Most people focus on the big federal numbers, but the local impact is immediate for homeowners. Lucas: It is. And let’s not forget consumer credit. Credit card APRs are closely tied to prime rates, which track the Fed Funds rate. With the effective rate at three point seven five percent, and banks adding spreads, many consumers are carrying balances at eighteen to twenty-five percent interest. That disposable income lost to interest payments is money not spent on goods and services, which eventually drags on GDP. Luna: So the high-debt, high-rate environment acts as a drag on consumption. Even though Q3 GDP was strong, that strength might be masking underlying debt-servicing stress for households. Lucas: Spot on. The three-point-four percent GDP growth was driven partly by inventory buildup and government spending, not just consumer confidence. As we move into Q4, if borrowing costs remain elevated, we’ll likely see a slowdown in durable goods purchases. Cars, appliances, home renovations—all sensitive to financing terms. Luna: It makes the Federal Reserve’s job incredibly hard. They can’t cut rates aggressively without risking inflation resurgence, but they can’t hike much further without breaking something in the debt market. Lucas: They are stuck in the middle. The market is watching every word from officials like Kevin Warsh, who is keeping Wall Street guessing about future policy paths. Uncertainty itself becomes a cost. Businesses delay investment because they don’t know if rates will stay at five percent or drop to three percent over the next two years. Luna: So the uncertainty premium is another hidden tax on the economy. It’s not just the explicit interest rate, but the risk that policy will shift unexpectedly. Lucas: Right. And looking at the yield curve, the spread between the ten-year and two-year is only thirty-seven basis points. That curve is flattening out, which historically precedes economic slowdowns. It suggests that short-term expectations are stable, but long-term growth prospects are dimming. Luna: A flattened curve often means the market thinks the Fed will cut rates in the future because the economy is weakening. So it’s a self-fulfilling prophecy of sorts. Lucas: Potentially. But until we see clear disinflation data, the Fed will hold steady. And until the deficit shrinks, the supply of Treasuries will keep pushing long-end yields higher. We are in a structural phase change for public finance. Luna: Structural phase change is a good way to put it. It’s not a cycle; it’s a new regime. Investors need to adjust their expectations accordingly. Lucas: Agreed. The era of free money is gone. The question now is how efficiently we can allocate capital in a world where money has a real, significant cost. That efficiency determines whether we grow out of our debt or get crushed by it. Luna: A tough road ahead, but at least understanding the mechanics helps us navigate it rather than just worrying about the headlines. Lucas: Absolutely. Knowledge is the best hedge against volatility. Thanks for tuning in to The National Debt Podcast.