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September 22nd, 2018

Insight

The giant sucking sound of a debt spiral

George Will

By George Will

Published May 7,2018

From Scotland, where Adam Smith pioneered systematic thinking about economics, comes an adjective, "carnaptious," that fits people who are allergic to economic euphoria. It means cantankerous.


Let's think carnaptiously about this fact: The interest rate on 10-year Treasury bonds recently rose briefly to 3 percent, and soon may move above this. This is more than evidence of the economy's strength. It also is a harbinger of a coming day when the great driver of the national debt will be ... the national debt. Pour a Scotch and read on.


The economy's growth, which slowed in 2018's first quarter, is not brisk; it still is not even the 3 percent that is the low end of presidential boasting. At the end of this month, the economy will amble into the 10th year of the expansion that began in June 2009.


This month is its 108th, making it almost twice as long as the average expansion (58 months) since 1945. Unless Mr. I Alone Can Fix It has banished the business cycle forever -- modesty would not have prevented him from mentioning this -- a contraction is somewhere in America's future.


It might begin in fiscal conditions resembling today's because this is now normal: trillion-dollar annual budget deficits while the economy is at full employment. (The 3.9 percent unemployment rate is impressive, even give the decades-long decline in the work force participation rate, which today is 62.8 percent.)


This is a result achieved when both ends of Pennsylvania Avenue are controlled by what still fancies itself a conservative party. What are the chances of fiscal improvements arriving after the electorate returns many congressional Republicans to the private sector of which they speak so fondly? The Manhattan Institute's Nicole Gelinas notes that "from the 1960s through the beginning of the financial crisis, Treasury rates never fell below 3 percent, and they were often several percentage points above that." In 2007, the Great Recession arrived in December when the national debt was $7.5 trillion and the average interest on it was 4.5 percent. Imagine paying 4.5 percent on today's $16.5 trillion debt.


The Congressional Budget Office projects that new federal borrowing over the next 10 years will total $12.4 trillion and that at the end of 2028, the debt will be $28.7 trillion -- 96 percent of GDP, up from 39 percent in 2008. But the CBO is required to pretend that Congress will not make matters worse. Its projections must assume the continuation of current law. So, the CBO must assume that the caps on defense and nondefense appropriations imposed in the Budget Control Act of 2011 will be enforced in 2020 and 2021. But those for 2018 and 2019 have just been discarded. How likely is a reversion to disagreeable discipline?


The CBO must also assume that Congress meant what it said (in order to cram a spending bill under parliamentary rules) about cuts contained in the new tax law expiring after 2025. Some legislators want to make those cuts permanent immediately. The American Enterprise Institute's James Capretta says of last year's CBO projection that the federal debt would reach 150 percent of GDP by 2047: Discard the mandatory fictions and that level is reached much sooner.

Gelinas says that by the end of 2017, Americans' household borrowing stood at $15.3 trillion, "just shy, in inflation-adjusted dollars, of what it was in 2005, the year before the housing bubble peaked."


And although "Americans are now spending less of their income on debt -- about 10.3 percent, down from roughly 13 percent between 2005 and 2008 -- they didn't use the period of super-low rates to reduce their debt, which means they're vulnerable to higher rates."


When such rates arrive, and debt service swells the debt, what can government do? When the Korean War erupted in June 1950, Congress slashed discretionary nondefense spending by 25 percent. Back then, however, such spending was 29 percent of the budget.


Today, sacrosanct transfer payments are 70 percent of the budget, paying debt service (7 percent) is mandatory, and discretionary nondefense spending is 15 percent. So, government cannot act as nimbly as it did 68 years ago.


Hillsdale College's Gary Wolfram notes that total discretionary spending -- including defense -- for fiscal 2019 is projected to be $1.362 trillion, which is just $381 billion more than the projected deficit. All this means trouble, unless Mr. Art of the Deal can negotiate with arithmetic, persuading it to amend its rules so that trillion-dollar deficits will not mean trillion-dollar increases in the debt.

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