This article explores the consequences of prolonged government intervention in the economy, particularly focusing on how it has led to distorted financial behaviors among Americans. With low-interest rates driving unsustainable borrowing, the fiscal landscape is changing drastically, creating challenging conditions for both consumers and businesses.
The prolonged period of low-interest rates, primarily a result of the Federal Reserve’s expansive monetary policy, has led many to misunderstand their borrowing capacities.
Currently, the yield on the 10-Year Treasury Note hovers around 4.11 percent. This figure, apart from a brief instance last fall, hasn’t exceeded 4 percent since mid-2008, marking the highest borrowing costs in over 15 years.
The ramifications of this situation are apparent and should have been anticipated.
As credit prices rise, so do the costs associated with servicing debt. This is straightforward. Borrowers—individuals, businesses, and governments alike—now have to allocate a larger portion of their finances towards managing their debts than they did just a year ago.
For some, these changes are manageable. They steered clear of the temptations of the Fed’s artificially low credit options. Their debts remained reasonable, allowing them to maintain a balanced lifestyle with some savings and investments. They possess enough cash flow to manage the increased debt burdens stemming from higher interest rates.
Conversely, for many, this is a dire predicament. They have accumulated significant debt, spending money as if there were no consequences. As of Q2 2023, total credit card debt in the United States surpassed $1 trillion for the first time.
In reality, many consumers have relied on credit cards to sustain their lifestyles amid rising prices. Yet, this reliance cannot continue indefinitely. The ticking clock of financial obligations will inevitably catch up.
Voices in the Night
The surge in credit card debt has coincided with unfavorable timing. As the Fed has increased interest rates over the past 18 months, credit card interest rates have soared as well. The average rate now exceeds 20 percent—an unprecedented high.
While 20 percent isn’t exactly predatory, it’s still a significant burden. Debtors won’t face violent consequences for non-payment, but the strain is substantial.
Consequently, many people have trapped themselves in a cycle of financial distress. The reality of their situations will be harsh when fully realized.
What will occur in the financial system when a large segment of the population is unwilling to dedicate much of their lives to repaying debts?
Adding to these challenges, student loan payments will resume on September 1, 2023, with borrowers required to restart payments in October. After nearly three years of relief, the relentless demands of student debt are poised to resurface with a vengeance.
For those juggling student loans and maxed-out credit cards, every dollar is critical. With rising interest rates, the squeeze will be felt even harder. They will need to scrutinize their expenses to find cash flow.
This may lead some to cancel subscription services, rediscover library resources, forego dining out, downsize their living situations, or even take on additional jobs—like working at a hotdog stand.
On the flip side, there will be individuals for whom meeting financial obligations becomes impossible due to overwhelming debt, leaving them with no choice but to declare bankruptcy.
This situation is not isolated to consumers; the same debt-strategizing dynamics are unfolding across various sectors of the economy.
Higher Debt Costs
Businesses are similarly grappling with the increased cash flow needed to meet obligations. What once seemed like a manageable financing scenario two years ago is now far from feasible under current rates.
This reality forces management to make difficult decisions, such as tightening budgets, reducing development efforts, closing divisions, and downsizing their workforce.
The impact of elevated interest rates will likely worsen in the coming years. A recent report from Goldman Sachs estimates that approximately $1.8 trillion of U.S. corporate debt will mature over the next two years, necessitating refinancing at significantly higher rates.
“Corporations needing to refinance existing maturing debt at today’s higher rates would face higher debt costs. Goldman’s economics team, led by Jan Hatzius, expects a 2 percent increase in interest expenses for corporations in 2024 and a 5.5 percent spike in 2025.”
As corporate debt obligations rise, businesses will respond by cutting labor and capital expenditures. Historical data indicates that for every additional dollar spent on interest, firms reduce capital spending by 10 cents and labor costs by 20 cents.
The flourishing labor market and low unemployment rates touted by President Biden and Treasury Secretary Yellen as indicators of a thriving economy may soon soften in the wake of maturing debt refinancing.
As businesses are compelled to adjust their workforce amidst a landscape of soaring consumer debt, unemployment rates are poised to rise, leading to more unpaid debts.
Tasting the Forbidden Fruit
Some companies won’t merely lay off employees; they may be driven to file for bankruptcy due to their overwhelming debt burdens.
Interestingly, Chapter 11 filings in 2023 have already surpassed the total for all of 2022, with U.S. corporate bankruptcies peaking at levels not seen since 2010. Major corporations like Bed Bath & Beyond, Virgin Orbit, Yellow Corp., SVB Financial Group, Diebold Nixdorf, Serta Simmons Bedding, and Party City have all succumbed to bankruptcy this year.
While some of these entities might restructure their debts and recover, others may fade into oblivion after their best efforts.
The coming years are likely to be challenging for both businesses and employees, and the current optimism for a soft landing could simply be wishful thinking.
It is crucial to recognize that consumers and businesses are responsible for their current predicaments. No external coercion compelled them to take on excessive debt; they made these choices themselves.
What was the expectation when loading up on unprecedented levels of debt while interest rates were at historic lows? Clearly, there was a lack of thorough consideration.
However, let’s remember that it was the Fed, alongside the Treasury, that lured many with the enticing allure of artificially cheap credit. This tempting offer was simply too irresistible for many to ignore.
They bit the fruit and, as forewarned, they will face the repercussions.
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Sincerely,
MN Gordon
for Economic Prism
