The Debt Spiral

Several Hoover Institution scholars write,

In recent months, we have seen an inevitable rise in interest rates from their low levels of recent years. Rising interest rates and increasing deficits threaten to build upon each other to send public debt spiraling upward even faster. When treasury debt holders start to doubt our government’s ability to repay, or to attract future lenders, they will demand higher interest rates to compensate for the risk. If current spending and tax policy continue unaltered, higher interest costs will have to be financed by even more debt. More borrowing puts more upward pressure on interest rates, and the spiral continues.

If, for example, interest rates were to rise to 5 percent, instead of the Trump administration’s prediction of just under 3.5 percent, the interest cost alone on the projected $20 trillion of public debt would total $1 trillion per year. More than half of all personal income taxes would be needed to pay bondholders. Such high interest payments would crowd out financing of needed expenditures to restore our depleted national defense budget, our domestic infrastructure and other critical government activities.

See the post from John Cochrane, one of the authors. If investors, including the Chinese government, grow leery of U.S. government debt, then my guess is that we will see the tactics that are known as “quantitative easing.” That is, the Fed will grow the supply of reserves, so that it and the rest of the banking system absorb a lot of government debt. The trick will be to keep banks from doing a lot of lending other than to the government. My guess is that paying a low rate of interest on reserves won’t be sufficient, and instead some form of financial repression will be needed. By that I mean regulating banks in such a way that buying government debt is approved while making business loans is frowned on.

17 thoughts on “The Debt Spiral

  1. 1) This is a very real problem
    2) Every time the Republicans, only, have discussed the real solution — reducing entitlements — they lose elections.

    Conclusion: politically, the Reps should continue spending as much, or more, than Obama — until the Dems start complaining about it. Entitlement reform isn’t going to happen until Dems support it, so Hoover (conservative) talking to Reps isn’t going to help.

    The blame must be put on the Dems, again and again, until they elect folk who have an agenda of reform.

    It’s also the Dems, not the Reps, who control the Ivory Tower pointy-head academics, who control the (Dem) Media, who control K-12 teacher unions and much of teaching, who control most of the NGOs.

    Until the Dems think it’s a serious problem, it’s not serious.

    (The solution is clear from Dan Mitchell — gov’t total spending needs to grow less than economic growth.)

    • Tom, I’ll be glad to vote for reduced entitlements as long as troops are brought home from Syria, Iraq, Korea, Afghanistan, Djibouti, Israel, Japan, Mali, and Niger. First the empire, then the entitlements.

  2. The worst outcome is lying about partial default, then doing it, as in Nixon Shock.

    • Please explain what “Nixon shock” was, and why it was a “partial default.”

      • Nixon rejected the contracted fiat price if gold and paper gold dollars were devaluaterd and gold horders got wealthy as gold shot up in price. It took ten tears to feetablishe the finance industry.

  3. If investors, including the Chinese government, grow leery of U.S. government debt, then my guess is that we will see the tactics that are known as “quantitative easing.”

    The two major foreign holders of U.S. Treasuries are China and Japan, and IIRC, they haven’t added to their combined net holdings in five years or more. Here’s a capture that has data as far back as September 2014, and you can see that they had more then than they do today.

  4. These scholars are just despicable, and no one should pay any attention to them.

    Why? Because they change their minds depending on what they want.

    All of a sudden this group cares about the deficit and its effects. This same group wrote:

    “In November, a group of Republican luminaries, including Michael J. Boskin, John H. Cochrane, John F. Cogan, George P. Shultz, and John B. Taylor co-authored an op-ed cheering on the Trump tax cuts. Isn’t it a little dangerous to permanently increase the deficit, especially during the peak of an economic expansion? Nonsense, they argued. The effect on interest rates of higher debt “is likely to be modest, given that the United States operates in an international capital market, which means that the impact of changes in interest rates resulting from greater investment demand and government borrowing are likely to be relatively small.”

    http://nymag.com/daily/intelligencer/2018/03/conservative-economists-turning-back-to-debt-hysteria.html

    I hope they all got whiplash.

    • The WSJ is quite awful with editorials. We want to know what others think only to find out they don’t. Just a waste of time. Arnold really needs better reading material.

  5. grow leery of U.S. government debt, then my guess is that we will see the tactics that are known as “quantitative easing.”

    Why? QE was put together between 2009 – 2013 at a time when the economy was arguably in a Keynesian 0% bound and by 2012 government debt fell along with commodities prices between 2012 – 2014. (The great oil price drop was the strongest evidence of the Great Recession 0% bound although I believe the price dropped from sudden Iraq supply.)

    1) Remember Donald Trump promised to protect Social Security and Medicare. I bet without it he does not win the election. Not only popular but very popular with the right group of voters.
    2) The striking teachers are in low tax Red States not the Blue states where they run the local governments. And ask yourself why would anybody become a teacher in OK or WV? (Where I am not sure how voucher system would work)
    3) If China avoids US debt and that would mean the Chinese Yuan should appreciate long run. So what happens to a variety of US products? And I still think China is following the Japan here. (And Japan has not collapsed.)
    4) We are in a sudden low labor supply and there are real pressures on wages. Average families are satisfied.

    I still think Fed acts first as we have seen several rate increases (in which economic libertarians swore would break the economy.) which has already been happening and the recession is a Fed Induced one like 1957/1958.

  6. I used to be a deficit hawk. But, no government or party can be trusted to put any spare or theoretical dime into deficit reduction. They always always always spend to the uttermost optimistic 10-year-horizon taxing/borrowing/printing maximum, and then more. No dime is reserve in any sense by either party for debt reduction. Surely these are end-game maneuvers, bribing banks to buy nothing in exchange for selling nothing back to the US Government. We will see tactics designed to kick the can down the road and blame the next guy.

    Therefore, we are screwed. As Mark Steyn says, we are a nation of negative millionaires, and may eventually leave the first world.

    And if we are screwed, I may as well keep as much as possible. Hence I vote for morons who promise more spending and tax cuts, instead of morons who promise even more spending without the tax cuts.

    • The politicians you elect hear you which is why they do what they do. They know it won’t matter at all for your vote because you don’t really care.

      • Thanks for responding. If there were a non-moron, who could be trusted with let us say a trillion, to put it into debt-reduction spinach instead of lower taxes/”star wars”/”war on poverty”/”shovel ready projects”/universal healthcare/unversal higher ed/”global warming”/cops on the street/cops in schools etc etc, then I would vote for same.

        I think the problem is not that the man doesn’t exist, but that he can’t exist.

    • I always wondered where all these millionaires would go. Most developed nations have similar government debt, China millionaires have to listen to the government, and Russia poisons people who don’t follow the system.

      India then? Australia? South America? (Corruption and government is still higher there.)

  7. I often think about the perishable nature of resources – the time and effort of labor being the most important example. If Joe Hardworker is unemployed for very long, his output is simply lost. (This applies to other things, but human time and energy is probably the most compelling example.)

    And so “printing money” (aka monetization of debt or quantitative easing or bank oppression as well as just creating money and giving it to the treasury) might be “OK” so long as its done just enough to draw most of the slack out of the economy. (Too much of course would create inflation.) Note here I explicitly mean creation (print money) rather than borrowing (create an obligation to somebody.)

    Seems to me that governments get in trouble when they try to slather over mismanagement or other fundamental weakness of their economy by printing tokens (money.) Handing out more $20 bills doesn’t directly add to the supply of labor, or any other resource. BUT handing $20 to literally everybody very well might drive unemployment down – and while there is unemployment, a perishable asset (time in a person’s life) is being wasted.

    For some time lots of “money” has been “created” by banks – and that was somehow OK (or more OK than just printing $20 bills) – presumably because the newly created money matched a debt with an asset, especially when that debt was held by somebody other than government.

    And those debts can loom very large indeed.

    But maybe such debts aren’t required – at least if there’s “enough” “slack” in the economy.

    (Surely somebody else has written this down?)

    ——————
    I think those who observe that (a) entitlements are the core of the problem and (b) trimming entitlements is politically impossible – are correct.

    • You’re also implicitly correct about the need to put workers to work.

      There is lots of talk about Universal Basic Income — this is a mistake.
      There should be more talk about Universal Guaranteed Jobs — so everybody gets offered a job.
      Cleaning places up.
      Repairing things.
      Taking care of old folk, taking care of young folk.

      There’s plenty of work, but not enough “jobs”.
      The US needs a guaranteed jobs (for citizens) program, so all citizens have a job offer that results in living above poverty.

      Folks should have the freedom to NOT work — but then lose other gov’t cash benefits. Other charity would be ok.

  8. “Such high interest payments would crowd out financing of needed expenditures to restore our depleted national defense budget,”

    OMG. That’s just pathetic.

  9. These figures are all from the CBO and you know how much we can trust that! Ha, ha!

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