US Economy, Megathreats, and Cost of Debt

In this educational article discusses a comprehensive journey through the latest economic data of the United States, exploring the Federal Reserve’s monetary response, shedding light on Treasury Inflation-Protected Securities (TIPS), and delving into the enlightening book, “Megathreats” by Nouriel Roubini. Additionally, gain valuable insights into the implications and expenses associated with rolling over existing debt in the US. A small video on hypothesis testing involving two tailed test or two sided test will be included at a later date to explain the simple regression used herein. Kindly refer to the statistics online course on The middle Road to know more. Register for free and access the online course. 

# Impressive Economic Indicators

📊 The US economy is showing significant progress, with a record-low unemployment rate of 3.6 percent and long-term unemployment rate above 27 weeks standing at just 18.5 percent. Additionally, the Real Gross Domestic Product (GDP) has grown at an annual rate of 2.0 percent in the first quarter of 2023, as per the “third” estimate. Though slightly lower than the 2.6 percent in the previous quarter, this growth still reflects a positive outlook amidst some concerns. The annual inflation rate has decreased to 3 percent in June this year, the lowest since March 2021. It appears that the unemployment rate might be close to the natural rate of unemployment or the non-accelerating inflation rate of unemployment (NAIRU).

NAIRU represents the level of unemployment when the economy operates at its potential output or full employment level. Keep checking The middle Road, especially its online courses, to explore various concepts in macroeconomics.

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The Federal Reserve (FED) responded to these economic conditions by raising policy rates by 25 basis points, taking them between 5-1/4 to 5-1/2 percent. The FED also focused on reducing securities holdings, specifically Treasury securities, agency debt, and agency mortgage-backed securities. FED Chair Jerome H. Powell highlighted an expansion in the labor participation rate among 25-to-54-year-olds compared to the previous year, indicating moderate economic activity.

# Inflation and FED’s Dual Mandate

The core PCE prices rose by 4.6 percent, and although inflation has moderated, it remains elevated, with the FED targeting 2 percent over time. The increase in interest rates could lead to tighter credit conditions for households and businesses, potentially weighing on economic activity. While the FED is committed to working on its dual mandate of maximum employment and stable prices, the outlook remains uncertain. The FED needs to carefully balance its approach, being data-dependent while maintaining a restrictive monetary policy.

Graph Source 

The middle Road enthusiastically recommends Nouriel Roubini’s book, ‘Megathreats,’ as an invaluable resource for gaining profound insights into the significant risks confronting humanity. Within the book, Roubini expertly illustrates the root causes behind the high inflation experienced in the United States during the 1970s, as well as how the Reagan administration successfully addressed and reduced inflation in the late 1980s. In ‘Megathreats,’ one of the critical concerns for the future is the possibility of experiencing Great Stagflation, characterized by both low economic growth and high inflation. However, upon analyzing the data, The middle Road outlook it is evident that the probability of stagflation occurring, at least in the US, has decreased compared to the situation a year ago, all else being equal. Looking at the positive data in the US i.e., resilience of the US economy, very low unemployment rate and lessening of inflation, The middle Road rules out stagflation in the US in near term. Further, it emerges that the recent banking turmoil will not spillover to a larger portion of the economy even if it leads to tighter regulations among banks.  

With its meticulous analysis and compelling narrative, ‘Megathreats’ provides readers with a comprehensive understanding of the grave risks that humanity faces, making it an indispensable read for anyone seeking to comprehend the complexities of today’s economic landscape.

# Treasury Inflation-Protected Securities (TIPS)

Treasury Inflation-Protected Securities (TIPS) offer a compelling opportunity for investors seeking real returns, particularly during periods of high inflation. Comprising approximately 6 percent of the US debt, TIPS come with various maturities ranging from 5, 10, to 30 years. These securities provide an effective hedge against inflation as they are directly linked to the Consumer Price Index (CPI). As inflation rises, the principal amount of TIPS increases, and during deflation, it decreases. Upon maturity, investors receive the higher value between the adjusted principal and the original amount from the U.S. Treasury, ensuring a guaranteed real return even in deflationary scenarios. TIPS also offer attractive asset diversification qualities, and they show a positive correlation with certain commodities, particularly Gold and Real Estate Investment Trusts (REITs). This correlation makes them appealing to investors looking to balance their portfolios with inflation-resistant assets. Diversification and prudent investment strategies are essential when considering the correlation between TIPS and commodities like Gold. Investors should seek expert advice and conduct thorough analyses before making investment decisions based on such correlations.

The middle Road conducted an analysis to explore the correlation between Inflation and Jewellery example Gold. Using data for the data of Producer Price Index (PPI) for Miscellaneous Products: Jewellery (Gold and Platinum) and Silverware as a proxy for Gold and Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average  (CPILFESL) for Inflation. Scatter plot with simple regression equation is mentioned in the graph. Producer Price Index (PPI) for Miscellaneous Products: Jewellery (Gold and Platinum) and Silverware is the dependent variable or on y axis and Consumer Price Index on the x axis. The data has a correlation of 32.35. The slope is significant at 95 percent confidence interval. (p value for the slope is 0.0081 rounded off, suggesting the slope is statistically different from zero). Though the analysis provides valuable insights, it’s important to acknowledge that the correlation coefficient may not fully capture all influencing factors, leading to a relatively low R-square due to omitted variable bias. This means the price for PPI for Miscellaneous Products is influenced by other factors apart from the inflation rate. While the analysis sheds light on the relationship between Inflation and Gold, it’s crucial to consider other factors and conduct further research to gain a comprehensive understanding of their interplay. Consult your financial advisor for a more informed discussion for investing.

Graph Source: 

Data used is from Jan- 2018 to June 2023, monthly, percentage monthly change from year ago. Sample N=66. For PPI, Index 1982=100, the data is not seasonally adjusted. Consumer Price Index data is seasonally adjusted. US. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items Less Food and Energy in U.S. City Average [CPILFESL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPILFESL, July 28, 2023. Index 1982-1984=100, Seasonally Adjusted. U.S. Bureau of Labor Statistics, Producer Price Index by Commodity: Miscellaneous Products: Jewelry (Gold and Platinum) and Silverware [WPU159402], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WPU159402, July 28, 2023

# Debt and Costs of Rolling Over  

• According to a report titled Assessing the Costs of Rolling Over Government Debt by Julian Kozlowski, Senior Economist Samuel Jordan-Wood, Research Associate, sheds light on the composition of the US government’s debt and highlights the trade-off involved in managing different types of debt instruments to meet financial obligations effectively. As of the fourth quarter of 2022, the US Treasury Department reported that the total public debt reached slightly above $31.4 trillion. Out of the $31.4 trillion, approximately $7.5 trillion or 23.9 percent constitutes nonmarketable debt. This primarily includes the social security trust fund, military retirement funds, and the civil service retirement fund. The remaining $23.9 trillion represents marketable debt, of which $2.5 trillion consists of variable-rate debt.
• Much of the debt is rolled over with government coming out with similar government security of same amount and duration but at prevailing interest rates. This means that the interest payment resets at higher interest rates. This is a better approach than to finance long term debt with short term debt. Long term debt i.e., the debt of maturity larger than 1 year is about 70 percent of the overall debt. Overall, according to the stated paper, the estimated total US interest payments over GDP increases from 1.86% to 2.23% since a smaller portion of the debt is long term in 2023. This 0.37% increase in interest expense, amounts to about incremental $98 billion amount paid on interest.  Over a medium to long term, the interest expense of outstanding debt becomes substantial. Congressional Budget Office (CBO) estimates that the projects interest expenses to GDP will increase from 1.9% to 3.6% in the next 10 years. It’s imperative that the US shows a higher degree of fiscal prudence rather than monetary juggernaut to tide over the deluge in interest expense. Another option with the FED would be inflation taxation and the use of use zero-interest reserve requirements.  

Suggested Further Reading 

• Assessing the Costs of Rolling Over Government Debt by Julian Kozlowski, Senior Economist Samuel Jordan-Wood, Research Associate
• Fiscal Dominance and the Return of Zero-Interest Bank Reserve Requirements by Charles W. Calomiris
• Press Release Federal Reserve issues FOMC statement
• Megathreats by Nouriel Roubini 
• Image Megathreats: Amazon 

If there are discrepancies in the data or if you need further assistance regarding the content provided, it’s best to reach out to the email address of the author Nishant, nishant@themiddleroad.org, for further clarification and discussion. They will be able to address any specific concerns or provide additional information related to the content of the article. The note about two tailed test is added after the initial publication of this article. 

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