There are two basic questions: Who will now be financing the U.S. government’s massive borrowing needs, and at what price?
There are two basic questions: Who will now be financing the U.S. government’s massive borrowing needs, and at what price?
W hile Washington idles about our budget problems, the bond vigilantes and the rating agencies are sending us a clear message: Our country’s public finances are burning. Unless we get serious about mending our public finances, our children’s economic prospects could be irreparably damaged.
To say that our public finances are highly compromised would be a gross understatement. At a time when unemployment is very low and we should be running budget surpluses, we are managing to run an 8 percent-of-GDP budget deficit. That has already sent our public debt (in relation to the size of the economy) to stratospheric levels that were last seen at the end of World War II. The Congressional Budget Office is warning that, on our current budget trajectory, our public-debt-to-GDP ratio could rise to a Greek-like 110 percent before the end of the decade.
It is all too easy to blame the Biden administration for our current budget mess. With the American Rescue Plan Act, Infrastructure Act, and so-called Inflation Reduction Act, the budget deficit has ballooned. However, the truth is that both sides of the political aisle must bear responsibility for the sorry state of our public finances.
As we have seen with the Biden administration, the Democrats in office like to spend like drunken sailors, but they are more reluctant to raise taxes — except on the wealthiest, and there are not currently enough of them to make enough of a difference. As we saw during the Trump administration, the Republicans in office liked to cut taxes aggressively, but they were not prepared to cut public spending by amounts anywhere near enough to pay for those. The net result of this lack of any real political constituency for budget responsibility is that our public debt is now on an exponential, upward path.
The increasing tendency of our government to get deeper in debt has not been lost on the bond vigilantes. Nor has the fact that foreign governments (such as China and Japan) who were previously major buyers of U.S. Treasury bonds have been losing their appetite for additional, large-scale U.S. bond purchases. It also has not helped that the Federal Reserve, which until the beginning of last year was a major buyer of U.S. Treasuries under its quantitative tightening program, now is not rolling over its maturing Treasury bonds as part of its effort to regain inflation control.
All of this has raised two basic questions in the markets: Who will now be financing the U.S. government’s massive borrowing needs, and at what price? Little wonder, then, that the bond vigilantes have returned and that the all-important, ten-year Treasury-bond yield, which serves as the benchmark for other long-term interest rates, has recently spiked to almost 5 percent.
Little wonder, too, that the rating agencies are taking note of our deteriorating public finances and Washington’s political dysfunction, both of which make early remedial action to our public finances unlikely. Fitch and Moody’s have changed the U.S. government’s credit outlook to negative. A downgrade in our credit rating would compound our budget problems by, all things being equal, raising the interest rates at which the government would be forced to borrow.
Some of the consequences of our budget irresponsibility are already being felt. As a result of the recent spike in Treasury-bond yields, mortgage and auto-loan interests have surged to 8 percent, the highest level in 16 years. Those interest rates are bound to be a major headwind to recovery and increase the pace of loan defaults. Meanwhile, interest payments on the government debt are skyrocketing. The Committee for a Responsible Budget estimates that interest payments are the fastest-growing part of the budget; they now constitute the fourth-largest component of public spending behind Social Security, Medicare, and defense.
History is littered with examples of countries that have experienced major exchange-rate crises and bursts of inflation because of irresponsible budget policies. For the sake of this country’s future, we have to hope that Washington soon mends its budget ways. If not, future generations should expect to have lower living standards than those to which we have been accustomed.