Facing up to the Fiscal Facts of Life
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Girard Miller
October 2, 2019
America’s founding fathers anticipated that there would be federal budget deficits to pay for national defense in wartime. Jefferson paid for the Louisiana Purchase with borrowed money. Keynes opened a new field of macroeconomic thinking with his approaches to counter-cyclical government spending and borrowing. Americans are accustomed to paying for everyday expenses and not just emergencies and durable goods with revolving credit cards. So perhaps it should come as no shock that the United States national debt now exceeds $22 trillion, and the federal budget deficit is running at a $1 trillion level, even during a period of economic expansion and, “Full employment.”
Continued bipartisan warnings about the sustainability of perpetual debt finance have been sounded by the Governmental Accountability Office, the Joint Committee on Taxation, the Committee for a Responsible Budget and the Peterson Foundation, to name a few. Nobody seems to be listening. Que sera sera and carpe diem seem to be the national attitude toward deficit finance nowadays. Fiscal discipline in Washington DC has been largely abandoned in favor of low-tax budget deficits funded by historically low interest rates in a sluggish global economy with $18 trillion of negative-yield foreign sovereign bonds pulling down interest rates in the United States.
Proponents of Modern Monetary Theory (MMT) have extrapolated (or is it highjacked?) the Keynesian model and argued that none of this matters. MMT posits that the central bank, our Federal Reserve, can buy up bonds without any inherent limitations, and expand the money supply out of thin air, while the rest of the world allows us the privilege of reserve currency status. Whether that unproven theory could ever withstand the test of time would, of course, depend on future policy decisions and election outcomes that nobody can now predict.
One fiscal fact of life that MMT and the deficit doves cannot ignore, however, is Einstein’s, “8th Wonder of the World,”: the power of compound interest. With deficits running at record levels during a business expansion cycle, and destined to balloon far larger in the next cyclical recession, the modern borrowing binge continues unabated. When the Social Security and Medicare trust funds become depleted, an additional layer of borrowing from central banks and foreign investors will be necessary. Interest on the interest will compound as budget deficits grow. It’s the fiscal equivalent of rising sea levels.
The problem with this scenario is that today’s low interest rates are unlikely to last forever. Inflation now runs below 2% which is laudable on one front, but there remains a risk that quantitative easing and fiat monetary expansion will eventually spook the global bond markets in the coming decade. With T-bond yields at two percent, the budget’s capital markets risk is asymmetrical with infinity the only upside limit. All it would take for United States Treasury interest costs to become the largest component of the federal budget is either (a) ten more years of borrowing at current levels or (b) market interest rates returning to levels that prevailed even before the, “Baby Boom,” petrodollar-fueled monetary inflation of the 1970s. If monetary expansion does indeed result ultimately in currency depreciation and price inflation, then the interest on federal debt can easily, “Crowd out,” discretionary domestic spending. Today’s low tax rates cannot possibly remain intact in that scenario, even without major new universal spending initiatives as proposed by populist political campaigners.
At a purely technical level, there is at least one band-aid that can be deployed by the Treasury department, which is reportedly studying the concept: Issuance of large volumes of long-term bonds at historically low interest rates would help mitigate the interest-on-interest compounding risks of endless deficits. The more that today’s Treasury department can sell 20-, 30-, 50- or even 100-year bonds to willing investors, the lower the risk that maturing debt must be refinanced in the future at escalating interest rates similar to those experienced in the 1970s. For many years, there was a fear that large issuances of long bonds would jeopardize the domestic mortgage market, but that is unlikely as long as Treasury bond issuance is focused on maturities much longer than the 10-year note (which is the, “Handle,” for mortgage-rate hedgers). Even if long-bond rates were to rise a full percentage point from current levels, that would not pose much of a risk to ordinary borrowers. Corporate pension funds and life insurance companies would welcome higher-yielding long-duration assets; so would foreign investors.
At the political level, there will be a mounting incentive for the party out of power in the White House to campaign on a credible promise to address the annual budget deficit and to shore up social Security and Medicare to make them fiscally sustainable. Whether that happens in 2020 is still too soon to know. This posture need not require sacrificing pet campaign promises, but rather can be accomplished by a pledge to match every dollar of new spending with a dollar of deficit reduction funded by tax reforms and prudent tax increases. Such a fiscal strategy would actually go a long way toward mitigating the mounting risk of runaway national debt and monetary inflation that seems so benign today, yet still poses a lurking threat to our American democracy.
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This article was adapted from, “Part I: The Fiscal Facts of Life,” in the author’s new book Enlightened Public Finance, which addresses fiscal literacy for the 2020 elections. Other chapters address various tax reform options, and specific national health care and infrastructure financing strategies. The author’s net proceeds will be donated to the Government Finance Officers Association’s public finance scholarship program. Paperback copies are now available through online retailers and directly from the publisher without retail commissions: https://store.bookbaby.com/book/Enlightened-Public-Finance, whereby one-half of the purchase price will be donated.
Author: Girard Miller received an MPA degree in 1973 from the Maxwell School at Syracuse University, and an MA in Economics from Wayne State University in 1978. Now retired, his 30 year career spanned the governmental, nonprofit and investment communities. Twice the president of national mutual funds, he served on the Governmental Accounting Standards Board, and has authored several publications for the Government Finance Officers Association, where he is an honorary life member.
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Facing up to the Fiscal Facts of Life
The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization.
By Girard Miller
October 2, 2019
America’s founding fathers anticipated that there would be federal budget deficits to pay for national defense in wartime. Jefferson paid for the Louisiana Purchase with borrowed money. Keynes opened a new field of macroeconomic thinking with his approaches to counter-cyclical government spending and borrowing. Americans are accustomed to paying for everyday expenses and not just emergencies and durable goods with revolving credit cards. So perhaps it should come as no shock that the United States national debt now exceeds $22 trillion, and the federal budget deficit is running at a $1 trillion level, even during a period of economic expansion and, “Full employment.”
Continued bipartisan warnings about the sustainability of perpetual debt finance have been sounded by the Governmental Accountability Office, the Joint Committee on Taxation, the Committee for a Responsible Budget and the Peterson Foundation, to name a few. Nobody seems to be listening. Que sera sera and carpe diem seem to be the national attitude toward deficit finance nowadays. Fiscal discipline in Washington DC has been largely abandoned in favor of low-tax budget deficits funded by historically low interest rates in a sluggish global economy with $18 trillion of negative-yield foreign sovereign bonds pulling down interest rates in the United States.
Proponents of Modern Monetary Theory (MMT) have extrapolated (or is it highjacked?) the Keynesian model and argued that none of this matters. MMT posits that the central bank, our Federal Reserve, can buy up bonds without any inherent limitations, and expand the money supply out of thin air, while the rest of the world allows us the privilege of reserve currency status. Whether that unproven theory could ever withstand the test of time would, of course, depend on future policy decisions and election outcomes that nobody can now predict.
One fiscal fact of life that MMT and the deficit doves cannot ignore, however, is Einstein’s, “8th Wonder of the World,”: the power of compound interest. With deficits running at record levels during a business expansion cycle, and destined to balloon far larger in the next cyclical recession, the modern borrowing binge continues unabated. When the Social Security and Medicare trust funds become depleted, an additional layer of borrowing from central banks and foreign investors will be necessary. Interest on the interest will compound as budget deficits grow. It’s the fiscal equivalent of rising sea levels.
The problem with this scenario is that today’s low interest rates are unlikely to last forever. Inflation now runs below 2% which is laudable on one front, but there remains a risk that quantitative easing and fiat monetary expansion will eventually spook the global bond markets in the coming decade. With T-bond yields at two percent, the budget’s capital markets risk is asymmetrical with infinity the only upside limit. All it would take for United States Treasury interest costs to become the largest component of the federal budget is either (a) ten more years of borrowing at current levels or (b) market interest rates returning to levels that prevailed even before the, “Baby Boom,” petrodollar-fueled monetary inflation of the 1970s. If monetary expansion does indeed result ultimately in currency depreciation and price inflation, then the interest on federal debt can easily, “Crowd out,” discretionary domestic spending. Today’s low tax rates cannot possibly remain intact in that scenario, even without major new universal spending initiatives as proposed by populist political campaigners.
At a purely technical level, there is at least one band-aid that can be deployed by the Treasury department, which is reportedly studying the concept: Issuance of large volumes of long-term bonds at historically low interest rates would help mitigate the interest-on-interest compounding risks of endless deficits. The more that today’s Treasury department can sell 20-, 30-, 50- or even 100-year bonds to willing investors, the lower the risk that maturing debt must be refinanced in the future at escalating interest rates similar to those experienced in the 1970s. For many years, there was a fear that large issuances of long bonds would jeopardize the domestic mortgage market, but that is unlikely as long as Treasury bond issuance is focused on maturities much longer than the 10-year note (which is the, “Handle,” for mortgage-rate hedgers). Even if long-bond rates were to rise a full percentage point from current levels, that would not pose much of a risk to ordinary borrowers. Corporate pension funds and life insurance companies would welcome higher-yielding long-duration assets; so would foreign investors.
At the political level, there will be a mounting incentive for the party out of power in the White House to campaign on a credible promise to address the annual budget deficit and to shore up social Security and Medicare to make them fiscally sustainable. Whether that happens in 2020 is still too soon to know. This posture need not require sacrificing pet campaign promises, but rather can be accomplished by a pledge to match every dollar of new spending with a dollar of deficit reduction funded by tax reforms and prudent tax increases. Such a fiscal strategy would actually go a long way toward mitigating the mounting risk of runaway national debt and monetary inflation that seems so benign today, yet still poses a lurking threat to our American democracy.
+++++++++
This article was adapted from, “Part I: The Fiscal Facts of Life,” in the author’s new book Enlightened Public Finance, which addresses fiscal literacy for the 2020 elections. Other chapters address various tax reform options, and specific national health care and infrastructure financing strategies. The author’s net proceeds will be donated to the Government Finance Officers Association’s public finance scholarship program. Paperback copies are now available through online retailers and directly from the publisher without retail commissions: https://store.bookbaby.com/book/Enlightened-Public-Finance, whereby one-half of the purchase price will be donated.
Author: Girard Miller received an MPA degree in 1973 from the Maxwell School at Syracuse University, and an MA in Economics from Wayne State University in 1978. Now retired, his 30 year career spanned the governmental, nonprofit and investment communities. Twice the president of national mutual funds, he served on the Governmental Accounting Standards Board, and has authored several publications for the Government Finance Officers Association, where he is an honorary life member.
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