The federal deficit is a problem that matters. Most of the time, when we hear “the deficit is a problem,” it comes without supporting facts. We simply apply the same rationale as we would with our household expenditures. Namely, that if we spend too much, we’re going to have a problem. We’ll have to pay back our overspend with interest, and correspondingly we’ll have less money to spend on things we need in the future.
To some degree, the household example bears similarity to the fiscal considerations of national deficit and debt. It’s just much more serious at the national level. Where we, as individuals, can make prudent financial choices to mitigate our personal debts, uncontrolled government deficits affect all of us. Here’s why the national deficit matters for Americans.
First off, there’s the interest rate issue. On paper, because U.S. interest rates are historically low, this would seem to be a good time for government to borrow money for investments. President Trump often makes that case.
And even at the lower end of projections, medium term U.S. economic growth significantly exceeds the cost of borrowing. That means current interest rates should be easily offset by future economic growth. Correspondingly, current government borrowing should pay for itself. But there’s a catch: That argument assumes government borrowed money will be spent boosting the economic potential of the nation.
It’s a big assumption. After all, government is manifestly less productive than the private sector. It wastes a lot of money on things that do not boost economic productivity.
Moreover, interest rates are not static, and as long as the government runs deficits, anything borrowed at today’s rates will be refinanced at tomorrow’s. The Federal Reserve believes its quantitative easing has lowered long term borrowing interest rates by about 1 percent. But as the Federal Reserve unwinds that borrowing, interest rates will rise.
The Congressional Budget Office gives some context as to why this matters. Last summer, the CBO projected that if current spending plans hold firm, net interest payments on the debt will more than quadruple in relation to the economy, from 1.4 percent of GDP today to 5.8 percent of GDP in 2046. As I’ve noted, “To put that in perspective, had the U.S. spent an extra 4.4 percent GDP on debt service in 2015, it would have added $790 billion to the federal budget deficit.” By 2026, just nine years from now, the CBO projects government interest rate payments will double as a percentage of GDP. That amounts to hundreds of billions of additional dollars spent simply on paying off debt interest.
That’s money that cannot be spent on education, highways, the military, or any other government priority.
And that’s just the start. Another problem is that as deficits and interest payments rise, national saving declines. And that decline means reduced private investment opportunity. If we accept, as the vast majority of economists do, that effective investment is the key to boosting productivity and thus wages and living standards, the debt’s role in crowding out investment is a big problem.
Then there’s the issue of the dollar as the world’s reserve currency.
At present, foreign entities hold around 40 percent of all publicly held Federal debt (that is, not counting the IOUs held in Social Security and other entitlement program trust funds). But as the deficit grows and we avoid resolving its cost drivers (an aging population joined to unaffordable entitlements), American debt will become more risky to hold. This week we got more bad news in this regard. We found out that the nation’s birth rate is also declining. That means fewer workers to pay for more elderly citizens.
As the prospect of a default grows — even if it remains remote — foreign investors will abandon the dollar. And the consequence will be an immediate and serious decline in the wealth of American families. Don’t believe me? Consider what Brexit has done to the British pound.
Just before Brexit, one British pound was worth $1.49. Today, one British pound is worth just $1.30. In dollar terms, Britons are now 13 percent less wealthy than prior to Brexit. How would you feel if you were 13 perent poorer?
The deficit and the debt matter. If we wish to leave a better nation to our children, we need to get a grip and reduce long-term spending.
