Alberto García M

June 20, 2023

In recent weeks, all the newspapers have been talking about the possibility
of a U.S. debt default and raising its debt ceiling, i.e. being able to borrow
more in order to be able to pay its current “credit”.

Let’s try to understand what this situation refers to from fundamentals.
Let’s suppose that your salary is $50,000 per month and if we multiply it on
an annual basis, it is $600,000 to define it as the annual income. When you
go to the bank and apply for a car loan or mortgage, they
take your income as a reference against your current debts (that is why
they make the famous “credit bureau” consultation) with the objective of
analyzing your economic solvency and how feasible it is that you can pay
your credits.

If you owe $100,000 in the sum of your credit cards, we could say that your
finances are stable and healthy, since you owe one-sixth of what you earn
in a year. Let’s change the scenario: you buy a car on credit for half a million
pesos; now you owe the bank about what you earn in a year.

How does my personal debt relate to the debt of an entire country?
Analogically is the way to explain it: imagine that the United States of all the
income it generates in a year, it owes. Would you be worried about owing
more than you earn in a year? If your answer is yes, imagine that an entire
country has this much debt, which is why it became one of the most
relevant news of the last few days.

Let us remember that debt is an alternative to acquire goods or invest in
certain businesses with the purpose of paying for them with our future
income. Basically, when a government gets into debt, it is with the purpose
of paying for its infrastructure projects, services and the expenses that
arise for the operation of governmental entities.

I understand the magnitude of the news, a greater indebtedness of the
United States leads to a riskier commitment because it could be said that
it begins to “overinvest”.

Can you imagine the most important economy in the world having
problems to pay its debts? It would be catastrophic, it is as if the millionaire
uncle had economic problems, being the pillar of a family economy.

Now imagine what happens at the country level where the strongest weakens, it
can wipe out economies such as Mexico’s.

The positive news came and the U.S. was finally able to raise its borrowing
capacity to pay its debts: the billionaire uncle received more credit to pay
his debts, ruling out the possibility that he might be in default on his credit

Following the news, markets and stock markets around the world showed a
positive advance, however, there are still unknowns to be solved given that
such debt has to be paid. It is important to mention that the real problem is
not raising the debt ceiling, but how to pay it and start reducing it.

Below, we will see a small graph of how US indebtedness has evolved over
the last few years.

Graphic 1 – Value of Debt (%) over annual U.S. GDP for each year at market

As can be seen, from 2003 to 2011 the percentage of US indebtedness
doubled and since then it has remained at levels of more than 100% of GDP
and in the pandemic year was when the debt was the highest.

Can we consider the U.S. to be over-indebted?
From a theoretical point of view, owing more than your annual income is
over-indebtedness, but a good benchmark is to compare the U.S. with other
nations of the world.

Graphic 2 – Debt comparison to the year 2021 among G20 economies

When interpreting the information in the graph, we are surprised to find that
Japan is the most indebted economy on the planet and it is difficult to find
negative news about its debt management, as this country relatively
controls it. Within economies with a debt greater than 100% of their annual
GDP, we find the main economies of Europe together with Canada.

With the above information, we can conclude that the US is relatively
over-indebted but still with the possibility of having a small margin to
increase its indebtedness, however, we have to consider that the value of
its debt is $29.48 billion vs. 12.78 of Japan’s debt.

What can this mean or be interpreted to mean?

It is clear that the U.S. debt remains at high levels, so the real challenge is
to reduce its debt and for this there are two routes: reduce its government
spending or increase its tax collection. Let’s go back to our example of
personal finances, in order to reduce over-indebtedness we will have to
adjust our personal expenses and tighten our belts or seek additional

The effects for savers and investors imply effects on the purchase of long
term US debt (such as 7, 10 or 20 year bonds) increasing its volatility
because the risk factor is increasing: lending money to someone you
consider over-indebted means a latent possibility of default. If the US
manages to start reducing this debt in relation to its GDP, the markets in
general will take this news positively and it will continue to be attractive to
invest in treasury bonds, otherwise, if the debt continues to behave in such
high ranges during the following years, it could start to be a trigger for a
financial crisis.

What scenario can we expect in the next 5 years?
It is difficult to imagine a world where the world’s leading economy has
problems paying its debt or cannot control its debt, so I am optimistic in
this regard. The expected scenario is that the US manages to stabilize its
debt through the economic tools to at least stabilize its debt in ranges of
approximately 120% of its GDP and this will be enough to keep the US bond
market stable and translate this calmness to the markets.

With the possible lower interest rates in the following years, there is the
possibility of reducing the debt of the world’s major economies, so that all
financial instruments containing medium and long-term government bonds
may have quite interesting annual returns (averages over 10%) for investors
who have acquired such bonds during 2022 and 2023.
At Grupo Hedeker, we monitor the main international indicators in order to
have the most accurate vision possible to position you in the instruments
that will keep you away from volatility in times of turbulence.

If you have any additional questions, please contact me directly at
agarcia@hedeker.com or on my social network LinkedIn as Alberto García