Megan McArdle on U.S. Government Debt

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.

FILED UNDER: Economics and Business, Government, ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. odograph says:

    I think anyone who wants to call this “Obama’s debt” has to say:

    “I would not have bailed out the banks, the pseudo-banks, the insurance companies, or the car companies, and I understand the consequences.”

    I appreciate that some here at OTB will stake that ground, but can they really paint a realistic picture of “no bailout world?” How much deeper would the economy have gone?

    Surely it would have been deeper, with trillions less coming from fiscal and monetary policy.

  2. PD Shaw says:

    odograph can always go with the other variation:

    any person who ever voted for a politician that ever proposed an unbalenced budget can never complain.

  3. just me says:

    “I would not have bailed out the banks, the pseudo-banks, the insurance companies, or the car companies, and I understand the consequences.”

    This is my position.

    I was told that we had to bail out the banks, but I am not seeing much evidence that we really had to.

    I sure as hell don’t think we should be protecting the unions by bailing out auto companies.

    I also don’t think we needed to take on a 3 trillion dollar stimulus package that nobody took the time to read.

  4. Bithead says:

    This is my position.

    And mine, for which I’ve been on record since the start.

  5. odograph says:

    You know, on one of NPRs shows about the credit crisis, they visited an American high school district that had been sold an “as safe as cash” instrument by Wall Street. It turned out, after the crash, to be some kind of MBS/CDS bond.

    When people say they’ll take the easy way, no bailouts, I don’t think they really process all the little failures that would occur around them as a result, and how that would affect the economy and their taxes, going forward.

    When the commercial paper market failed, healthy companies almost missed payroll. That was the thing that drove Pauslon to congress and put him down on his knees (literally).

    I’d love it really if all this spending was “extra” and could have been avoided, but I’m not convinced.

  6. JKB says:

    Well, I believe you’ll find that your school district is still going to lose their money, so bailing out the banks didn’t really help them. And the bailout of the car companies can hardly be called a success since Chrysler and most likely GM are going into bankruptcy anyway. Granted, now with the “Friends of Barack” program to give special deals to the supporters of the administration.

    What the markets are indicating is that the bailouts and stimulus are not seen as going to pay off so we’ll still have the problem to solve only with crushing debt this time. The administration is seen as willing to toss out the rule of law regarding finance when it suits them so default risk for the US has ticked up a few notches.

  7. Bithead says:

    When people say they’ll take the easy way, no bailouts, I don’t think they really process all the little failures that would occur around them as a result, and how that would affect the economy and their taxes, going forward.

    Oh, to the contrary, I thnk they do. But I also figure they’re looking at the bailout cure to be worse than the original problem.

  8. Wayne says:

    “any person who ever voted for a politician that ever proposed an unbalenced budget can never complain”

    Please get real. Politicians that you vote for do things you don’t like all the time. How many liberals complain about the war when Dems and Reps both voted for it?

    Also we usually have two choices in the end. One that spends like a drunken sailor and one who spends like a boat load of drunken sailors. Many of us complain when the Republicans spent too much so don’t tell us we can’t complain when the Democrats are running a bigger deficit in one year than Bush did in 8. Remember to that the Dems were in control of Congress for the last two years which is when the recession hit.

  9. Drew says:

    “I appreciate that some here at OTB will stake that ground, but can they really paint a realistic picture of “no bailout world?” How much deeper would the economy have gone?”

    It would have been deeper, in the short run anyway, by definition. But it seems implicit in your assertion that it would be much deeper. I do not see any basis for that.

    The fraction of the stimulus funds spent to date are very small. And wrt financial institutions, revoking the mark to market might have avoided the panic – and it was a panic, not a fundamental problem. I think concerns of meltdown have been overwrought from day, for political reasons.

    Separately, let’s partion bank bailouts for industrial company bailouts. We have a fractional banking system. Inherently fragile. And capital flows are like blood – necessary. So yes, you do what you have to do there.

    But if Chrysler goes under – spare me the violins – its just not the same problem.

    The smoking gun here actually was the recent prescription: taxpayers had a $5B claim wiped out; will put $6B of new money in, and get 10% of NewCo. The UAW has a $4B subordinated claim……….and walks away with 55% of NewCo.

    Spare me the economic hand wringing….this was raw political payback.

    We ain’t in Kansas anymore…….

  10. odograph says:

    But “revoking the mark to market” is what gave Japan their lost decade(s).

    This is the basic problem with arguing missing data, alternate histories. You can assert a “deeper in the short run” recession, and imply an as-rapid recovery … but on what basis?

    How does that alternate world turn around as fast? Surely unemployment would be deeper now, and consumer spending further down.

  11. Drew says:

    “But “revoking the mark to market” is what gave Japan their lost decade(s).”

    I don’t think so. They didn’t let banks that should fail, fail. They didn’t let industrial corporations that should fail, fail. They drip, drip, dripped in props. And they repeatedly put in stimulus that stimulated for a bit……until it didn’t. Not to meation asset collapse and demographics. Sound familiar??????

    The mark to market issue is a narrow point. You can have assets that have a long term intrinsic value (a “fair market value”) but in the moment have diminished “orderly liquidation” value, or “fire sale” value…..which is universally a pathetic value based upon current circumstances. Revoking mark to market simply would have avoided the fire sale valuations as the monetary system players sorted out each other’s balance sheets and exposures. Said another way, it would have avoided the panic. Operating in a state of panic is not a good way to manage assets.

    We have pretty much been able to sort out the banking systems assets and exposures in about 6 months. Japan farted around for years.

    Odo, I think you know this. And so invoking Japan and M2M is really, really weak.

    “You can assert a “deeper in the short run” recession, and imply an as-rapid recovery … but on what basis?”

    Say what? I agree with you that a more hands off approach would have necessarily made the recession deeper in the short run. After all, we’d have, for example, a bunch of laid off Chrysler workers right now. No surprise there. But that bailout has consequences for the future(financing), whether its higher taxes that can’t be spent elsewhere, higher interest rates from govt borrowing that retard financed consumption expenditures, or inflationary printing of money that destroys buying power. Look, I’m a classic U of C trained guy, but I have yet to see a refutation to the notion there is no free lunch. These bailouts just kicked the problem – and the lower GDP – down the road. This of course is the way of politicians.

    “How does that alternate world turn around as fast? Surely unemployment would be deeper now, and consumer spending further down.”

    See above. The classic logic problem with spending stimulus policy is that is substitutes stimulus today – for the benefit of economic players today – for less activity tomorrow – to the detriment of economic players tomorrow. Politically expedient, but economic witchcraft.

    If you really read the critique of economists re: Japan, you will see that it was just a series of kick the can down the road avoid troubled company reality and stimulus moves……while the debt continued to pile high. And it didn’t work.

    Sort of like the Obama approach, eh?

  12. PD Shaw says:

    The fraction of the stimulus funds spent to date are very small.

    As of today’s report from the Vice President, $28.5 billion of $787 billion stimulas has been spent, mostly on medical assistance to the states, which is slower than anticipated.

  13. Wayne says:

    Drew
    You made some good points.

    As for Odo
    “How does that alternate world turn around as fast? Surely unemployment would be deeper now, and consumer spending further down.”

    Part of the decline of consumer spending and investments is their confidence in our system. Could a failure of major industries and\or bank cause a panic and hurt this confidence? Yes and that was a big reason given for the bailouts. However I think many have overstated how much panic would have ensued. I think the constant strong arming of our government and its interference with our system is causing a even greater decline in confidence than if we would have left these industries and banks corrected themselves though our capitalist system. Now the government appears to be going after small banks and grabbing even more power. Not a confidence builder.The stimulus packet may have hurt our economy more in the short and long run than letting the sytem work itself out.

  14. odograph says:

    Drew, you need to clear up which path you are taking:

    1) “They didn’t let banks that should fail, fail. They didn’t let industrial corporations that should fail, fail.”

    2) “We have pretty much been able to sort out the banking systems assets and exposures in about 6 months. Japan farted around for years.”

    It seems to me you can take the no-bailout path, let them fail, per #1, but you can’t turn around and claim the benefits in #2, of the bailouts.

  15. odograph says:

    To put it another way, Bush & Paulson, Obama & Geitner, and Bernanke across the 2 regimes, were all too afraid to let the “too big” fail.

    The reasoned argument about why they were wrong, and failing was safe, boils down to “well, Bush was really a Democrat and we didn’t figure it out until too late.” That is not a very rational economic argument.

    Neither is “well, things would have been better because failing all the failures would have invigorated the economy.” That is an appeal to emotion, without data.

  16. Drew says:

    C’mon, odo – Stop dancing around.

    The point simply was and is that letting these things sort themselves out relatively quickly is an effective way for market participants to assess, correct and move on. In Japan they didn’t let this happen for years.

    Had the M2M provisons that communicated panic valuations not been in place here the banking system would have similarly sorted things out (as they have in short order) without the need for bailouts. As we can see, its happened in the space of months, not years.

    Your comparison fails.

    Separately,

    “well, Bush was really a Democrat and we didn’t figure it out until too late.”

    Neither is “well, things would have been better because failing all the failures would have invigorated the economy.”

    Um, er, uh……..uh….odo, did you recently score a premo load of ‘lumbo?

  17. odograph says:

    My point is a simple one. We can all tell ourselves alternate histories. We can say that X would have been followed by Z … but we shouldn’t try to convince even ourselves, let alone others, of our fiction.

    We must always be aware that it is fiction, and such a fiction can never be a proof.

  18. odograph says:

    BTW, if you have some similar true-history where they did take the “let them fail” path, that might be convincing. The only similar thing I can think of now is the words of Hoover’s Treasury Secretary:

    And to quote from President Herbert Hoover’s autobiography, during his administration economic policy was made by quote “the leave-it-alone liquidationists headed by my Secretary of the Treasury Mellon, who felt the government must keep its hands off the economy and let the slump liquidate itself.”