August 18, 2022

Increasing Interest Rates May Blow Up the Federal Budget

Congress enjoys exorbitant politics privilege in the form of cheap deficit spending—but it may soon go to an end

In fiscal year 2020, at the height of covid stimulation mania, Congress managed to spend  nearly twice   what the federal government raised in taxes.

Yet in 2021, with Treasury debt piled sky high  and spilling  over $30 trillion, Congress was able to service this gargantuan obligation with interest payments of less than $400 billion. The total interest expense of $392 billion for the yr represented only about 6 percent of  the  roughly $6. 8 trillion   in federal outlays.

How is this particular possible? In short: very low interest rates. In fact , the average weighted price across all outstanding Treasury debt in 2021 was  well below two percent .   As the chart below shows, even  dramatically rising federal debt in recent years   did not much hike Congress’s debt service burden.

interest expense chart

This is an exceedingly  happy set up for Congress. Debt is always more popular than taxes for the same reason starting a diet the next day is more popular than starting today. Austerity does not sell when it comes to retail politics; spending trillions today while merely adding to what seems like the nebulous, faraway debt definitely  does . Plus American lawmakers are uniquely fortunate in this regard. As French finance minister  Valé ry Giscard d’Estaing infamously introduced in the 1960s, the  Bretton Woods monetary system created  “ America’s exorbitant freedom. ” He understood how the US dollar’s status because the world’s reserve currency will allow America  to effectively foreign trade inflation to its hapless trading partners while maintaining cheap imports at home. Yet he may not have fully grasped  the  political   privilege which would collect to Congress.

Is this privilege sustainable? That could well be the most important politics question of the twenty-first centuries.   As Nick Giambruno  explains , the forty-year experiment in non-stop lower interest rates may shortly end regardless of what the Fed does. Markets and geopolitics are powerful forces. Inflation, huge projected deficits, economic sanctions on Russia, oil disruptions, and a diminished urge for food around the world for propping up Uncle Sam forever all apply upward pressure on Treasury rates. The Fed proved it can and will serve as marketplace maker and backstop for all of us Treasurys, with its sordid QE (quantitative easing) bond buys after the Great Recession and it is deranged response to covid. However it cannot force investors, also crony  institutional investors, to purchase American bond debt in rates well below inflation forever. This is not hypothetical; Giambruno notes how certain Treasury yields quietly rose 5 time just since the absolute lows of 2020.

If Treasury prices continue to rise, and rise precipitously, the effects on congressional budgeting will be immediate plus severe. Even if we laughably assume total federal financial debt remains static at close to $23. 8 trillion (the publicly held portion of the $30 trillion), interest rates of merely 2 or 3 percent will cause interest expense to rise substantially. Average weighted rates associated with only 5 percent would cost taxpayers more than $1 trillion every year. Historically, average prices of 7 percent swell  that number to more than $1. 5 trillion. Rates of 10 percent— hardly impossible, given the Paul Volcker era of the late seventies  and early eighties— would certainly cause debt service in order to explode to over $2. 3 or more trillion.

Interest on debt within the hands of the public from different interest rates (billions)

Total financial debt in the hands of the public $23, 874. 2
Rate of interest Interest cost
1% $238. 70
2% $477. 50
3% $716. 20
4% $955. 00
5% $1, 193. 70
6% $1, 432. 50
7% $1, 671. 20
8% $1, 909. 90
9% $2, 148. 70
10% $2, 387. 40

Again, also 5 percent average rates would  cause debt support to become the single biggest annual expenditure for Our elected representatives — ahead of Interpersonal Security ($1. 2 trillion), Medicare ($826  billion), as well as the Department of Defense ($704 billion). The  beginning point  for spending budget makers every year would be any expense totaling nearly half realistic tax revenue. And keep in mind that these figures are usually for the  current   federal debt, exclusive of the vast long term deficits that are almost deceased certain to happen. Seniors like entitlements, and the percentage associated with Americans over sixty-five is placed to double by 2050. Republicans and Democrats such as war, busy as they are usually installing more US troops in Poland and envisioning new aircraft carriers to patrol the Mediterranean (yes) and the South China Ocean. What happens when the interest-bearing financial debt is $40 or fifty dollars or $60 trillion?

At some point, given the particular sheer and utter profligacy of Congress, will the entire world demand junk bond rates to loan America one more dime? Everyone knows the US will not pay its debts other than nominally through inflation; everyone knows off– balance sheet entitlement promises cannot be kept in any meaningful way. Spendthrifts get cut off eventually, even those with powerful militaries and hegemonic currencies. This may not happen soon, if for most reason than that the remaining world holds trillions people dollars too. But if American exceptionalism goes the way of the British Empire, this will be the reason why.

During the incontinent George W. Bush administration, Dick Cheney infamously chided Treasury secretary Paul O’Neill with all the assertion “ Reagan proved deficits don’t matter. ” We see the same  deluded thinking   today among proponents of modern monetary theory, the idea that sovereign governments can command assets at will. This mentality pervades Congress, which in turn is rewarded by voters who want wars  and welfare today with no thought to  future generations. They choose to believe the particular Cheneys and the MMTers, who have tell them deficits and financial debt are essentially costless.  

But financial debt and deficits do matter. We have been about to find out how much they will matter. The good news, and it is good news, is that Americans soon may enjoy the benefits of compounding curiosity on savings (our grandma and grandpa can explain this in order to us). Civilization begins and ends with capital build up, the very thing politics plus central banks attack with impunity. It is beyond time for you to reward savers and penalize Congress.

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