Is America Headed for a Debt Crisis?

 In COVID-19

The most recent fiscal forecast from the Congressional Budget Office sees a his­toric amount of debt in America’s future. Moving past the impact of the coro­n­avirus pan­dem­ic over the next few years, the CBO sees annual fed­er­al budget deficits increas­ing from 4 per­cent of GDP in 2026 to 13 per­cent by 2050. That would be larger in every year than the aver­age deficit of 3 per­cent of GDP over the past 50 years. The nation­al debt would be a lot bigger, too. CBO projects that by the end of 2020, fed­er­al debt held by the public is pro­ject­ed to equal 98 per­cent of GDP, 107 per­cent (“the high­est amount in the nation’s his­to­ry,” the CBO adds) in 2023, and 195 per­cent of GDP by 2050.

The CBO con­cludes: “High and rising fed­er­al debt makes the econ­o­my more vul­ner­a­ble to rising inter­est rates and, depend­ing on how that debt is financed, rising infla­tion. The grow­ing debt burden also raises bor­row­ing costs, slow­ing the growth of the econ­o­my and nation­al income, and it increas­es the risk of a fiscal crisis or a grad­ual decline in the value of Treasury secu­ri­ties.”

Source: Congressional Budget Office

Now, all those num­bers assume cur­rent laws gov­ern­ing taxes and spend­ing stay the same. But the cur­rent Democratic and Republican pres­i­den­tial can­di­dates have taxing and spend­ing plans that, if imple­ment­ed, would alter that status quo. Here is the “cen­tral esti­mate” calculation from the Committee for a Responsible Federal Budget: “… we find President Donald Trump’s cam­paign plan would increase the debt by $4.95 tril­lion over ten years and former Vice President Biden’s plan would increase the debt by $5.60 tril­lion. Debt would rise from 98 per­cent of Gross Domestic Product (GDP) today to 125 per­cent by 2030 under President Trump and 128 per­cent under Vice President Biden, com­pared to 109 per­cent under cur­rent law.”

Source: Committee for a Responsible Federal Budget

So more debt and bigger deficits. But how much is too much? It seems the gen­er­al con­sen­sus these days is that the United States has plenty of what econ­o­mists call “fiscal space.” But surely there is not unlim­it­ed fiscal space, even for the world’s lead­ing econ­o­my that runs the world’s most impor­tant cur­ren­cy. So on this sub­ject, let me high­light the thoughts of two great econ­o­mists that I‘ve chat­ted with on my pod­cast. First, Glenn Hubbard from last month:

Pethokoukis: It seems like it is very easy to work on eco­nom­ic policy these days, because you can come up with great ideas and you don’t have to explain how you’ll pay for them. There seems to be very little inter­est in debts and deficits and those kinds of fiscal con­straints. Do you still care about the debts and deficits, and if you do, do you feel like you’re in a small group that is shrink­ing day by day?

Hubbard: I do care, and I under­stand that I’m in a very small group, but I know that even­tu­al­ly, the worm will turn, and people will focus on this — not because I’m “right” but because math is math. You can argue about pol­i­tics, you can even argue about eco­nom­ics, but you can’t argue about arith­metic, and we are on a fis­cal­ly unsus­tain­able path.

Now, that doesn’t mean that the crisis is tomor­row, and it doesn’t even mean that we couldn’t make the addi­tion­al public invest­ment to raise pro­duc­tiv­i­ty. We could do those things, but the notion that we could start all new social pro­grams or have mas­sive spend­ing with­out think­ing about the future and have the Fed finance it is a fool’s errand. I worry that nobody in the polit­i­cal process is stand­ing for this.

Normally in an elec­tion year, we would see some ten­sion about this, but we’re not. One side says, “The deficits don’t matter, and we have one par­tic­u­lar idea.” Another side says “Deficits don’t matter, and we have anoth­er idea.” We do not see any budget con­straints for the people. It’s like the old days when menus in restau­rants some­times didn’t have prices on them. It’s easy to pick things when you don’t know how much they cost, and I worry the American people face that.

The longer we wait to make the choic­es we need to make, the more likely it is that there could be real damage by cut­ting sup­port for other things like research or edu­ca­tion or nation­al defense, cut­ting sup­port that seniors and others have come to expect, or rais­ing taxes to the point where we can’t have growth. I see these choic­es as very unap­peal­ing if we don’t act.

And here is Kenneth Rogoff, back in 2016 when the debt-to-GDP ratio was 76 per­cent:

Pethokoukis: Do you worry about the cur­rent levels of debt?

Rogoff: Well, obvi­ous­ly one ques­tion is at what hori­zon are we bor­row­ing? So if you’re bor­row­ing at 30 years, you can cer­tain­ly carry — it’s a lot less risky than if you’re doing all quan­ti­ta­tive easing and you’re bor­row­ing at overnight inter­est rates when those can change on you very sud­den­ly. Anyone who thinks we’re never going to have infla­tion again, there’s no risk that inter­est rates will go up, that’s nuts. We’re not — the United States is not a hedge fund and not just saying, well, there’s a 5 per­cent chance we’ll go bank­rupt, to the 95 per­cent chance we’ll make money. We have to bal­ance those risks and think about not just the level of debt, but what is the whole matu­ri­ty struc­ture of debt, what’s the pro­file. It’s pretty short at the moment after all this period of quan­ti­ta­tive easing.

Clearly, the US is in a posi­tion to take on more debt, and I think if you do it on infra­struc­ture spend­ing, improv­ing edu­ca­tion, it would be a good idea. On the other hand, if you say, “You know, we’re never grow­ing again, we’re in sec­u­lar stag­na­tion, so let’s just have a big party now and we’ll worry about it later,” that’s kind of crazy.

If I were to tell you that the US debt ratio in 2040 had dou­bled, was 150 per­cent of GDP, if that were the only data point that you knew, would you, with any con­fi­dence, be able to tell me any­thing else about the econ­o­my if you knew that one sta­tis­tic?

No. I wouldn’t because we also have the unfund­ed pen­sion lia­bil­i­ties that have very sim­i­lar prop­er­ties to debt. We’d need to know the matu­ri­ty struc­ture of debt. You need to know a lot of things. The United States is clear­ly in a much better posi­tion than coun­tries like Italy, even France or Greece. The United States is still the world cur­ren­cy and can do much more. But it’s a ques­tion of the pro­file of risk. You say a lot of people on the left favor having more debt. I guar­an­tee you if the right is in power and they’re doing things that create more debt, the same people on the left would be saying that is ter­ri­ble.

I’ve heard econ­o­mists say that per­haps in the future we’ll be like the bank of Medicis in Renaissance Italy where people will just want to hold US bonds as a place to put their money. They could care less that the inter­est rates are low or neg­a­tive. They’re just look­ing for a safe haven in a dan­ger­ous world and, there­fore, rates will be low for­ev­er, and as long as we’re not doing crazy things with the money, now is the time just to be spend­ing what we need to spend. [Are those who worry about CBO debt fore­casts] miss­ing the new envi­ron­ment we’re in?

Are we really obsess­ing about it? I mean, when Mitt Romney ran in 2012, he was going to have a huge increase in debt on what Republicans wanted to spend it on. Trump is going to have a huge increase in debt on what he wants to spend it on. The Democrats are going to have a huge increase in debt on what they want to spend it on. And a lot of this con­ver­sa­tion about — you know, wor­ry­ing about debt is actu­al­ly the side that’s not in power com­plains about it because they want to be able to spend the money, they want to be able the way they want to spend it. So I tend to think that that car­i­ca­ture that somebody’s wor­ried about debt tends to sort of miss where the real debate is.

I think to the extent we’re spend­ing it on pre-school, early child­hood edu­ca­tion, to the extent we’re spend­ing it on useful infra­struc­ture, that’s an invest­ment and it pays off and you can carry it better. And on the other hand, to the extent that you really believe, as many on the left do, that we’re not grow­ing any­more and we should just con­sume as much as pos­si­ble now in sort of pure con­sump­tion, that’s a harder case to make. And, again, you have to look at the matu­ri­ty pro­file of debt and not just at the level of debt. It’s a risk man­age­ment ques­tion. That’s the core of the issue.

National Interest source|articles

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