Even pre-pandemic there was concern regarding the level of Federal debt – which has been on a steady upward march since the turn of the century. For 2020, the Federal debt (with the impact of COVID 19) will reach 136% of U.S. GDP. Meaning the debt owed would be 136% of the total economy’s production.
Spurred-on by historically low interest rates, U.S. businesses have also been on a borrowing binge. Unfortunately, a collapse in sales accompanied the pandemic and businesses across the economic landscape experienced debt defaults.
Why The Debt Matters
Government Debt – A Long-term Concern
The Federal Reserve has dramatically lowered the cost of borrowing by reducing the Federal Funds rate to essentially 0%. The Fed Funds rate influences all other debt interest rates- from car loads and credit cards to U.S. Treasury bonds and notes. This means that borrowers pay very little for assumed debt.’
For now, the Federal Reserve has guaranteed a market for U.S. Treasury debt; thereby, reducing the yield the government needs to offer to entice borrowers. Once the economy recovers; however, the Fed will likely raise rates to stave off inflation. Over time these higher interest payments will consume a greater portion of the budget and reduce spending on infrastructure and other national needs.
Corporate Debt – A Current Concern
With a growing economy, borrowing helps businesses expand their production, workforce, marketing, and scaling. But today many businesses are turning to the debt markets simply to stay afloat – hoarding cash reserves in the event the future economic landscape deteriorates.
As a result, future growth in the private sector could be constrained as debt payments crowd-out more productive investments, similar to government spending, only more so as companies face declining profits and weaker consumer demand.
So far, the Fed has assisted the corporate debt market by purchasing bonds and notes and sustaining demand and providing new capital – which has eased fears and helps explain the continued uptick in the stock markets even as the economic output has declined due to the pandemic.
But, the Fed can’t save or bale-out everyone!
What To Do
The current high levels of government and private debt will impact the near and long-term economic outlook. The Fed has pledged to keep short-term interest rates near zero for the foreseeable future. This means businesses with cash and cash equivalent investments (CDs, money funds, etc.) will earn essentially nothing on their funds.
What businesses, of all sizes, need to do is invest in their own infrastructure. Investment in their digital platform while spending on expanding their market-reach and differentiating vs. their competition will be money well spent. Repositioning, re-pricing and re-fashioning products/services to cater to the changing shopping behaviors by consumers and customers.
All businesses should FEAR the high debt levels that government and companies have amassed. There is a direct correlation between the amount of business debt to the rate of business defaults. The Fed cannot continue to bail-out the economy so it is now the time for businesses to position themselves for the future.