Megan McArdle has a good article on govenrment debt and the problems that taking on too much debt can pose.
So why should we worry about the ability of the government to borrow? For the past decade, at least, the American government has been able to borrow pretty much all the money it wanted without seeming to pay much of a price in terms of higher interest rates. Bush’s deficits were worrying in a number of ways, but they certainly didn’t crowd out private investments, and we got a good deal on the money.
But Obama’s spending plans are extraordinarily ambitious. His projected deficits for the rest of his possibly presidency are higher than the “runaway” deficits that plagued most of the Bush administration–and after the first few years, that’s not stimulus, that’s ordinary spending outstripping revenue. For a while now, I’ve been asking people at conferences, on and off the record, what America’s sovereign debt risk is? That is, how long until people stop treating treasuries as the “risk free” securities, and start demanding a premium for the risk that we might default.
But last Thursday, the Treasury auction was . . . well, descriptions vary from “weak” to “horrible”. This raises the unpleasant possibility that markets are, as my business school professors insisted, “forward looking”. Voters may believe that getting a bunch of special interests to agree in principal that costs should be cut is the same thing as actually cutting costs. Bond markets don’t. That’s why James Carville famously wanted to be reincarnated as the bond markets so he could “intimidate everyone”.
Hmmm, I was hinting that this could be a problem a few weeks ago, and a reason why we might want to be careful with stimulus spending. I wrote back then,
At the same time the current recession will likely result in a budget deficit of at least a trillion dollars this year and probably next. Further, we have TARP, the current stimulus plan and a $75 billion dollar proposal to help bailout homeowners sideways on their mortgages and talk of TARP 2.0. All of this could add close to $2.3 trillion dollars to the national debt. Adding on the deficits just due to reduced tax revenues and we are looking at $4.3 trillion dollars, at least. Currently the national debt is around $10 trillion. So in a few years we could be looking at a national debt of $14 trillion dollars. [1]
In addition as I have mentioned several times Medicare and Social Security are in actuarial imbalance to the tune of at least $40 trillion dollars. Further, the problem with Social Security and Medicare are not that far off.
All of this combined could make foreign buyers of U.S. government debt very cautious of buying even more. The U.S. could have to offer such debt at a higher interest rate. The effects of this would be to reduce potential economic growth for the foreseeable future. The higher interest rates would likely mean less investment in productive private endeavors reducing growth. Further, since we’d have a harder time borrowing the government might resort to increasing taxes simply to pay for some of this spending. And to make matters worse even higher taxes might be needed to try and address the magnitude of the national debt. All of these things would mean slower growth.
Also, this part is noteworthy,
Obama can assure voters that he inherited these deficits. But bond markets pay closer attention to the fact that Obama has already increased the projected deficit he inherited by 50%:
And as is noted in Megan’s article, how much should President Obama be allowed to distance himself from these inherited budget deficits. Did Obama vote for or against TARP? Did Obama vote for or against other spending proposals? If he voted for them, presumably he thinks such programs/proposals are fine and he shouldn’t be allowed to distance himself too much from them.
Megan notes that perhaps the recent bad bond auction was just a bad bond auction and that we should be too careful reading too much into it. Quite so, but I think there is cause for some concern and we should keep an eye on future bond auctions.
Photo via flickr usere Mike Turner, used under the Creative Commons license.
