Andrew Stuttaford at National Review wrote a column this week reviewing a paper by Brian Riedl for the Manhattan Institute about the danger of a federal debt crisis if the Federal Reserve increases interest rates.
Riedl’s paper serves as a stark reminder of the potential scale of a severe debt crisis. His initial critique is of the accepted belief that continuing expansions of federal spending are justifiable as long as the total federal debt remains less than 150 percent of GDP.
He points out that the federal government has already been projected to run a baseline deficit of at least $112 trillion over the next three decades. That amount of already expected additional debt will run more than 200 percent of GDP. Annual deficits will exceed 13 percent of the entire national economy by then. Interest payments on the federal debt would take up almost half of all federal tax revenue and would be the most significant single expenditure of the federal government.
That assessment is based only on existing expenditures and does not include any new spending contemplated by Joe Biden’s “Build Back Better” budget reconciliation spending bill.
Riedl also points out that today’s unrealistic economists assume that the artificially suppressed interest rates arranged today by the Fed will last just as they are, forever. Since 1990, the federal government’s average interest rate on its debt has dropped from 8.4 percent to 1.4 percent. Even though mainstream economists cannot say why the rate has fallen so much, they are willing to assume it will never go back up.
If actual interest rates on the national debt went back up to even 5 percent with current obligations only, the debt would skyrocket to 300 percent of GDP. Riedl observes that the Fed might be expected to bring rates up to at some point in the future to slow down price inflation affecting the economy.
The further complication could be plummeting demand for U.S. bond debt. If major international economies sense weakness in the U.S. bond market, most notably China, dropping out would devastate the American economy in ways that cannot be legitimately predicted.
America’s looming debt crisis is a simple math problem at the end of the day. Unfortunately, that only serves to undercut further confidence that anyone in Washington can deal with it in any other way than the traditional trickery and hand-waving.