When it comes, the restructuring of America's debt will have a profound, long-term global effect.
WITH world markets taking a breather on their wild ride south it is worth wondering what is next for the US, the world's largest economy.
In short, things don't look great.
This is not the story of default, collapse and apocalyptic end-of-days. Rather, it is the story of grinding, long-term economic malaise that infects almost every part of the US economy but for some surprising reasons.
Despite recent market ructions, the major problem remains the same. The US has a boatload of debt that it needs to pay off over a reasonable time frame.
The problem of how to deal with such debts doesn't get solved in a minute sometimes not even in a decade.
The hard truth of historical experience is generally countries do not simply pay down such high levels of debt.
Note well, Tea Party: as a general rule the problem is not solved by budget cuts, nor is it solved by new taxes.
Countries with shaky credit histories and a US-style level of debt generally default or restructure their debts and this path to default or restructure is exactly what we are seeing with Greece and probably a few of Portugal, Ireland, Italy and Spain.
It is unlikely, despite our current car-crash fascination with worst possible outcomes, that the US will either default or meet its bankers (think: China) to restructure its debts.
What is much more likely is the US will follow paths regularly used by developed countries to cut the interest bill.
Whew. No debt default by the US must mean that the world can pretty much rock along as it always did. But, sadly, no. The way the US keeps its interest bill down has a profound knock-on effect on US banks, the US economy and, by reducing the country's considerable economic influence, to us.
At its simplest, the US keeping its interest rates low on its debts effectively robs investors of the kinds of returns they might otherwise expect.
For the past couple of years academics Ken Rogoff and Carmen Reinhart have been exploring the methods used by developed countries in the past to cut high debt levels.
They note that developed countries generally have not defaulted or restructured their debts. But in a move you'd have to consider to be fairly sneaky, they largely achieve the same aims by cutting their interest bills.
These strategies include limiting the amounts of non-government debt assets held by banks on their balance sheets limiting or banning foreign debt assets and straight-out requirements for banks to hold government debt.
Other measures have included caps on interest rates for deposits in banks making government bonds more attractive and demands for superannuation funds to hold the "assets".
"Pension funds have historically provided the 'captive audience par excellence' for placing vast sums of government debt at questionable rates of return," Rogoff and Reinhart state in the working paper they released earlier this year, A Decade of Debt.
Here is the rub.
If the US is paying low rates of interest on its huge pile of debt, it pays its debts more quickly.
But it only does so by effectively ripping off the whole economy.
It is the reverse of the old saw: in this version the US socialises the gains and privatises the losses.
Banks don't make as much money on assets they hold on their balance sheet, therefore they don't return as much to their investors. Nor do they have as much cash available for other classes of investments that kick-start the economy, such as home loans or business loans.
Pension investors also don't have as much money to retire on, because they have been forced to hold low-yielding US government treasuries. The amount of money available for pension funds to invest in business is also reduced.
Why would a country impose such an economy-stifling system on the private sector?
Partly because it works: Reinhart and Rogoff estimate such measures cut the US government's interest bill by 5 per cent of gross domestic product annually between 1946 and 1955.
Also partly because there is little alternative: the US debt burden probably won't shift markedly with any level of budget cuts or new taxes.
The US doesn't want the cataclysm of defaulting on its loans.
It seems it would rather starve its banking system and rob its pension investors for years to come.
Frequently Asked Questions about this Article…
What does “US debt restructuring” mean and why does it matter for everyday investors?
In the article, US debt restructuring isn’t presented as an immediate default but as a long-term process that reduces the government’s interest bill. For investors this matters because the methods governments use—like keeping interest rates on Treasuries low or requiring financial institutions to hold government debt—can lower returns across banks, pension funds and other investments and dampen economic growth over time.
Is a US debt default likely, or will the US restructure its debts like Greece?
The article argues a US default or formal renegotiation with foreign creditors is unlikely. Instead, the US is more likely to follow tactics used by developed countries to cut interest costs without a formal default—measures that keep rates low and shift the burden onto domestic financial institutions and investors.
How can the US keep its interest bill low without defaulting on debt?
According to the article (and the academics it cites), countries have used measures such as limiting non‑government debt assets on bank balance sheets, banning or restricting foreign debt holdings, requiring banks to hold government bonds, capping deposit interest rates to make government bonds relatively attractive, and forcing pension funds to hold government debt. These policies lower the effective interest the government pays.
What effect do low government interest rates have on bank profitability and bank lending?
When the government keeps interest rates on its debt low and banks are steered toward holding that debt, banks earn less on the assets on their balance sheets. That reduces returns to bank investors and leaves banks with less cash to deploy into home loans, business lending and other investments that help the broader economy.
How are pension funds and retirement investors affected if the US forces them to hold low-yield government bonds?
The article explains that pension funds can become a ‘captive audience’ for government debt. If pension funds are required or pressured to hold large amounts of low-yield Treasuries, retirees end up with smaller retirement balances and pension funds have less capital available to invest in businesses, which can slow economic growth.
Why would a government impose policies that seem to ‘rob’ investors and weaken the private sector?
The article notes two main reasons: first, these policies work at cutting the government’s interest bill (historically significantly so), and second, there are few politically acceptable alternatives—large enough tax hikes or sustained spending cuts are difficult. Governments therefore often prefer policies that avoid formal default but shift costs onto private investors and institutions.
What historical research supports the idea that governments can reduce debt costs by steering domestic finance?
The article cites academics Ken Rogoff and Carmen Reinhart and their working paper 'A Decade of Debt.' They document that developed countries have often reduced their interest bills by using the kinds of measures described above. Rogoff and Reinhart estimate such tactics cut the US government’s interest bill by about 5% of GDP annually between 1946 and 1955.
If the US pursues low-rate strategies to manage debt, what should everyday investors monitor?
Based on the article’s discussion, investors should watch for policy moves that influence where financial institutions must put money—rules changing bank balance‑sheet requirements, restrictions on foreign debt holdings, caps on deposit rates, and directives for pension fund allocations. Those signals can help indicate whether government policy is steering capital into low‑yield Treasuries and what that might mean for bank profitability, pension returns and broader investment opportunities.
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