Over on Twitter, Jack Salmon writes:
How much was spent on government debt servicing costs in the first 3 months of: FY21 = $87 billion
FY22 = $102 billion
FY23 = $144 billion
FY24 = $216 billion 2.5-fold increase in just 3 years.
Projections of interest payments for fiscal year 2024 are around $900 billion, up from $352 in FY 2021. These interest payments will continue to consume a significant share of the budget in years to come even if the Fed reduces interest rates, as it claims it will in the coming months.
That got me thinking about policy-making, or its end, more precisely. Salmon and I wrote a study a few years ago in which we argued that considering the explosion of entitlement spending, the policy-making abilities of the next president and those who will follow him or her will be limited because such a large share of the budget is already committed. Today’s large increase in interest payments makes that even worse.
Voters should therefore be skeptical of those who promise big spending expansions of government, such as a large-scale industrial policy, a new national guaranteed income, or federally funded paid-leave programs, with offsets.
Another point to make about these enlarged interest payments: Kevin Hassett had a good piece last week laying out reasons why he believes “inflation hasn’t been whipped yet,” contrary to markets declaring victory and pundits praising Chairman Powell for his soft landing. I agree. I will add that the large growth in interest payments paid for by more debt also makes me skeptical that the fight against inflation has been won.
Treasury securities derive their value from expected future payoffs, discounted to the present. That’s no different from other assets. The payoffs for government-issued bonds are primary surpluses (budget surpluses excluding interest payments). Higher expected payoffs — primary surplus — raise demand for bonds and their value. That means better borrowing terms for the government. Lower payoffs mean less favorable borrowing terms. All we have ahead of us are primary deficits as far as the eye can see. Add to that pile of red large increases in borrowing to pay for interest on the debt. It will make it hard for the Fed to return to its 2 percent inflation target, which in turn makes me worried about the announcement of the rate cuts.
By the way, this is why I now think that contrary to CBO projections, we aren’t going to reach 180 percent of debt to GDP. I don’t think people will be willing to absorb all that extra debt. As a result, the price of the debt will be driven down, and inflation and interest rates are going to take off. The debt-to-GDP ratio isn’t going to rise to 180 percent because some part of the debt will be deflated. We have seen this happen in the last year with inflation being an important factor in bringing the debt-to-GDP down.
If I am right, the reality is scarier than the current CBO projections. Inflation is a terrible affliction.
The only way out of this mess is for Congress to do its job and get our deficits under control — and yes, that means reforming entitlement programs. The prospect of this happening is distressingly low.