Federal spending is too high. But federal tax revenues are also too low relative to the spending levels that the public “wants.”
When federal deficits are high, interest rates also move higher in order to attract capital, both domestic and foreign. Higher interest rates raise the cost of capital for investment, including path-breaking research and development spending. Moreover, when the budget of the federal government is larger, resources for the most productive areas of the country are lower. Investment suffers. Productivity suffers. Everyone is less prosperous. Trickle-down does work. Trickle-up policies, such as more welfare and income transfers, are the path to the fiscal graveyard.
BIDEN WIELDS FEDERAL GOVERNMENT’S BUYING POWER TO BOOST GREEN ENERGY
Congress and the Biden administration are laughing as they walk past the economic graveyard of our children and grandchildren.
The well-respected Committee for a Responsible Budget just released an updated long-range forecast of federal budget deficits. The CFRB explained that the deficit picture looks substantially worse than just six months ago when the Congressional Budget Office released its new baseline budget outlook.
Economic growth will be lower. Tax revenues will be lower. Interest rates on the federal deficit will be higher. The CFRB said that the net federal debt held by the public, domestic and international, will reach 110% of GDP by 2032. In that year, the structural deficit will be 6.6% of GDP, and annual interest payments on the debt will be 3.4% of GDP — or $850 billion in current year dollars.
To put that $850 billion number in perspective, defense spending for the current fiscal year, which began Oct. 1, is projected to be just under $800 billion. Interest costs are crowding out spending, which protects the existence of the U.S. as a sovereign democratic power.
Most disturbingly, I’d argue that the CFRB is actually way too optimistic about the deficit.
The Federal Reserve is fighting inflation by raising interest rates. When the Fed raises interest rates, the cost of borrowing by the federal government increases. Today, the federal funds interest rate is in the range of 3.75% to 4%. Federal Reserve Board of Governors is clearly signaling that the rate of federal funds will increase substantially from current levels. Last week, St. Louis Federal Reserve Gov. James Bullard raised the specter of a 6-7% federal funds interest rate. Today, the net deficit is approaching 100% of GDP. Each 1% increase in borrowing costs equals $250 billion. A 6% federal funds interest rate could increase federal government borrowing costs by up to $500 billion a year, or another 2% of GDP.
To make the deficit picture even bleaker, Fed Chairman Jerome Powell has promised slower growth in order to lower inflation. Many economists, including Larry Summers, a Democrat, say a modest recession is necessary. In a recession, when tax revenues are lower and automatic federal government spending is higher, economic stabilizers begin. Deficit spending rises. During the Great Recession, the federal deficit reached over 9% of GDP, a substantial increase from the 2009 structural deficit of around 3% of GDP.
Equity markets are betting on a mild recession beginning sometime in 2023. Federal Reserve Chairman Powell is right, significant economic pain is coming. On the looming deficit crisis, both the administration and Congress are silent. In fact, Republicans want to cut taxes, and Democrats want to raise welfare spending.
Political leaders of both parties are laughing as they dig the fiscal graves of our children and grandchildren who will inherit $35 trillion of federal debt.
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James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
