One of the greatest financial lessons or benefits I ever received was long ago in university when RBC started handing out credit cards to students. Look at me, I’m an adult! I would think, as I slapped it down in the pub.
The beauty of the card was that it had a $500 limit, because banks aren’t stupid. But young people certainly can be. For a young person learning their way in the financial world, that chained beast was the best possible introduction to credit, ever. The first month of profligacy was very good indeed, even though I didn’t set out to max out the poor little thing. I understood the concept of a loan, and paying it back, but…it was just so easy. Buy something, and my bank account never budged. Just twenty bucks, or whatever. That’s nothing. So what would it hurt to spend another twenty? And so on.
And then of course comes the hangover when the bill arrives. Whereas once I had X dollars to live on for a month, and that was not a very large X, now I only had 0.8X to get me through the month, because 0.2X had to pay back the tomfoolery. It was a powerful lesson in the problem of debt. Looking for change under the seats of my car to buy some food on the day before payday (real) is a sobering experience.
It is obvious what happens if one starts living on debt. It just runs away on you. Had I continued on that dangerous path, in the second month of credit card living, if I’d not paid off the balance, I would only have had 0.75X to live on, even if I never used the credit card anymore, because interest accumulates. This is not a trifling matter, and credit card companies, no doubt under legislative force, point out exactly how bad it becomes. Another real life example: As a points hound, I dump a lot onto the card but pay off the balance monthly. If I didn’t, if I chose to make the designated Minimum Payment, the the bottom of a recent statement explains that, quoting verbatim, and repeat repeat I am not making this up, “If you make only the Minimum Payment each month, we estimate it will take 102 year(s) and 2 month(s) to fully repay the outstanding balance.”
Well then. Debt 101: If you can’t repay it comfortably, don’t borrow it. Every adult simply has to learn that equation, no matter how challenging it might be.
But shockingly enough, our elected leaders never seem to. Politicians seldom heed this advice, because they are using Other People’s Money, and the failure to rein in debt levels is not really personally consequential. Their profligate ways, using taxpayer money, are rewarded with a pension, even if things go horribly wrong. But that is how our incentives systems work; vote buying trumps debt management, we continue to vote for it, and we get it. Good and hard.
But sometimes reality creeps in and forces action. At certain points in time, a crisis looms that is large enough to force governments to act on debt levels. It happened in Canada in the 1990s, as chronicled by the Bank of Canada: “Canada’s other major economic problem in the early 1990s was large budget deficits—federal and provincial. Because of these deficits, public debt was accumulating at an unsustainable rate, and foreign and domestic investors were becoming very nervous about holding Canadian government bonds. As a result, significant risk premiums were built into our interest rates…By 1994, it had become clear that Canada could be facing a potentially very serious debt problem. If there was any doubt about that, it disappeared in early 1995, when Canada was sideswiped by the Mexican peso crisis. The Canadian dollar came under strong downward pressure, and interest rates rose sharply across all maturities as investors demanded even larger risk premiums.” In that instance, Canadian politicians did act, because they had to, because, at one event in particular, lenders balked at loaning Canada any money at all.
The US is headed down a similar path. As of September, US government total debt exceeded $40 trillion. In early 2022, that number was $30 trillion, so $10 trillion added in 4.5 years. I wonder how many years it would take to pay this off at the Minimum Monthly Payment…
Which calculation thereof brings up a very big problem, a problem that is driving much of the mayhem we see in the world today.
The significance of US debt cannot be underestimated in everything from trade wars to the Iranian war.
The US, and most large western economies but particularly the US, cannot afford higher interest rates. But as fixed payment obligations grow and receipts do not keep up, the ability to maneuver gets tighter.
In the short term, governments can influence short term rates, to some extent, with government policy, or just by yelling at the fed chairman. Whether the latter works or not is debatable, but at any rate there are things the government can do to influence interest rates in the short term.
Longer term, economic theory says that interest rates will rise if investors have expectations of higher future inflation. I’m sure there are reams of data to support that thesis, so I don’t dispute it, but the phenomenon can be viewed in more recognizable terms: at some point, if you are a bad credit risk, people will simply charge a higher rate of interest to compensate for the risk. See: every single credit card ever issued. Or Canada in 1993. As things get shakier at the macro level, as debt piles up, and the ability to repay seems weaker and weaker, the demanded return can only go up.
The latest wrinkle in the debt issue is AI, which is shaking the earth even in debt markets. The AI rollout, via capital spending on data centres, is growing at an astonishing rate. Latest estimates have 2026 data centre spending at around $800 billion, rising to over $1 trillion in 2027. Much of this capital is now on borrowed money, meaning big tech companies are wading into debt markets like never before – historically, the industry’s mighty cash flow led to large cash surpluses (which they could loan out to the market), so this is a massive shift in debt markets. And these companies are willing to bid up yields to get what they want.
It is an odd scenario we are in, where an industry’s debt demands, almost out of nowhere, can be so large as to impinge on government’s ability to borrow, at exactly the wrong time. But that seems to be happening, and the US government really cannot afford higher monthly interest payments. The days of going to da club with da credit card are over.
As Luke Gromen put it on Twitter/X, US interest payments plus interest-like obligations (entitlement programs, veterans cost) are now 105 percent of federal tax receipts. These entitlement/social programs are growing at 7 percent per year, while federal income is growing at 4 percent per year. If entitlement programs like social security are considered unavoidable, then something has to give.
Ironically, the AI boom is must likely about to accelerate the problem in another way. As Gromen points out in an excellent interview, if all that AI investment succeeds, or even part of it, a lot of white collar/high paying jobs will be eliminated. That is devastating enough socioeconomically, but even more so for the government, because it will erode the tax base and diminish income tax receipts. AI could cause the government to pay more in interest rates and cut income, in the short term. The bet of course is that over the longer term, the benefits of AI will dwarf all else, and that could be true. But that could also be years after potentially mass unemployment. Just as with attempts to re-industrialize, to attract manufacturing back to the US. A great idea, but structurally a whopper – it will take decades, and the target is a moving target. China is using AI to bolster its already staggering manufacturing capability. The US needs a leap forward, not a crawl.
Of particular interest to us energy folk is the role of oil (and natural gas should be included in the discussion, but seldom is, but anyway). Going back to the competition for debt in global markets for a second: to repeat, economic theory says that investors demand higher interest for longer term borrowing when they have higher inflation expectations. Future oil price expectations can therefore become problematic. Oil is a subcomponent of almost everything in our industrial landscape, in one way or another. If not directly consumed as gasoline or diesel in supply chains, oil is turned into, or helps create, the basic industrial building blocks of our society.
If investors think oil prices will be higher in the longer term, then inflation expectations are similarly altered, and then surprise surprise long term interest rates start going up. This expectation loop is real, for better or worse; the Bank of Canada sends out a monthly “how is everyone feeling” survey that asks participants to quantify expected price changes over the coming years. They don’t do this for fun.
So that expectation cannot be allowed to build, and thus we have odd spectacles like US Treasury secretary Bessent telling the world that as soon as Iran is taken care of, “we actually could see oil prices $40 or $50…” Hmm, what is this peculiar absurdity? Anyone that pays attention to the energy sector knows prices at that level are highly destructive to production. And Bessent surely knows that too. But Mr. Bessent is Secretary of the Treasury, and he is vitally interested in lowering the US’ interest costs, and is therefore trying to bend investor psychology into believing that oil prices will crash and inflation won’t be a problem and only idiots would expect oil prices and inflation to be high down the road. Oh wait, it’s probably the other guy that would make that last point. But anyway, Bessent is trying to guide inflation expectations. He isn’t outright lying; in the very short term prices can tumble to those depths, but don’t stay for very long. He doesn’t want to talk about that part.
If high oil prices are such a concern, why pick this point in history to go after Iran so hard? And this is where it gets even more complicated.
One of the US’ key high-level objectives is to re-shore industry, which means essentially reclaim that capability from China. As it turns out, Iran is highly allied with China, and the Iran/China/Russia axis is very much interested in a multipolar world in which the US is not dominant. China has helped Iran evade US sanctions by buying oil, of which it is structurally short. These transactions limited American persuasive powers over Iran by making sanctions less effective, and benefitted China through cheaper crude. In taking on Iran, the US is disrupting this alliance and hampering Iran/China’s continuous efforts to be a destabilizing force in the Middle East. On top of all that, the US enjoys its position as globally financially dominant as this status – such as being the world’s reserve currency – provides options that do not exist otherwise.
So the war in Iran is one arm of the giant machine that has been put into action to help restore the US to financial health: bring manufacturing home, increase economic activity, pay down debt, be able to afford social/military spending commitments. You can scratch your head at the attitude of the architects, but that is it in a nutshell. Drastic times call for drastic measures, and these are indeed drastic times.
And what of Canada? Our debt situation is equally serious, but our circumstances are different. The US’ disruption of global trading patterns in the name of re-shoring has caught Canada in its crosshairs, and our comfortable world has been thrown into disarray. We are not nimble enough at present to build what we need to do quickly to rewire international trade, and, given the decision framework that was baked in over the past decade, it is extremely challenging for Canada to figure out where to go from here. A sheer sense of panic has created a great enthusiasm for nation-building projects; we will have to see how that plays out.
We have the same debt problem, and fewer tools to deal with it. But we are not without our strengths; commodities – hard assets – are a very great thing to have in abundance while this debt/currency turmoil is going on.
At the peak of the energy wars, The End of Fossil Fuel Insanity challenged the narrative of imminent fossil fuel demise, facing into the storm. Read the energy story for those that don’t live in the energy world, but want to find out. And laugh. Available at Amazon.ca, Indigo.ca, or Amazon.com.
Email Terry here. (His personal energy site, Public Energy Number One, is on hiatus until there are more hours in the day.)