By: Stephen Miran – nationalreview.com –
Federal-government debt that exceeds 100 percent of GDP is wildly irresponsible.
THIS week’s downgrade of the United States by Fitch Ratings is both absolutely merited and totally absurd. It’s absurd because ratings are fundamentally about default risk and the United States has no foreign currency debt, and it has a central bank
capable of creating money to pay back sovereign debt; so actual default is unlikely.
Moreover, the prominence of the 14th Amendment during recent negotiations to raise the debt limit underlined that outright default would probably be unconstitutional and
thus legally impossible.
At the same time, the downgrade is absolutely merited, because the debt dynamics of the United States are becoming increasingly untenable amid Washington’s wildly reckless overspending. While the bipartisan Fiscal Responsibility Act to raise the debt ceiling curtailed a small amount of deficit growth, the Congressional Budget Office still expects federal-government debt held by the public to reach 115 percent of gross
domestic product in a decade, up from the current level of 93 percent.
Treasury’s own projections indicate debt reaching around 250 percent of GDP by the middle of the century, and almost 600 percent of GDP by its end; compounding interest works great for savers but horribly for borrowers. These are nearly incomprehensible levels of indebtedness, and unless we tax the economy into oblivion, they’d end up requiring almost all revenues to be dedicated to interest payments on the debt, leaving nothing left for government functions. For context, debt was about 35 percent of GDP on the eve of the Global Financial Crisis, and it was stable at around 75 percent until the pandemic.
While the odds of default are low because the Federal Reserve can always buy bonds with the dollars it prints, the risk of real losses is very high because, as the share of tax revenue required for interest payments increases, the odds of government tolerating much higher inflation increases. And that would mean losses in real terms for bondholders. Indeed, if we reach a state of affairs where Treasury requires printed dollars from the Fed to roll over debt, we are probably facing hyperinflation and severe losses in real terms; the risk of that can be high even if default risk is low. In this sense, the downgrade is legitimate. A triple-A sovereign credit should not have debt ratios in excess of 100 percent of GDP, even if it is the world’s reserve currency.
In 2020, with a 10 percent hole in the economy due to pandemic stay-at-home orders and forced shutdowns, the $2 trillion-plus CARES Act was well timed to prevent a second depression. Indeed, the fastest recovery from a recession in post-war history, ushered in by the CARES Act, would have quickly helped limit its long-term budgetary impact. Ratings agencies were correct not to downgrade the government for using
available fiscal space to respond to a once-in-a-century public health crisis; policy should remain prudent in normal times precisely to leave space for emergencies.
But by the time we got to 2021, and thanks to the vaccines, the economy was healing of its own accord, and further support was not only unnecessary but counterproductive and a classic waste of funds. The American Rescue Plan, the Infrastructure Investment and Jobs Act, and the highly inflationary Inflation Reduction Act collectively pumped trillions of dollars into an economy at the worst possible moment in the cycle, ultimately
generating 9 percent inflation. With real interest rates at the highest level since the early 1980s, we are seeing classic crowding out of investment activity, further distorting
and impairing the supply side of the economy and lowering long-term potential growth.
Moreover, even after the legislation was enacted into law, the Biden administration has continued to find new ways to increase needless spending — for example, expanding the definition of sport utility vehicles to include a number of sedans, so that more luxury cars would qualify for IRA electric-vehicle subsidies, exacerbating the taxpayer burden for the sake of carmakers and driving record increases in car prices. While the CBO originally scored the cost of climate subsidies at under $300 billion, they have subsequently had to nearly double their estimate, and some independent forecasters expect the IRA provisions to end up costing almost $800 billion.
Perplexingly, Fitch also decried “repeated debt-limit political standoffs” for eroding confidence. On the contrary, the debt limit is one of the few effective devices available in our political system to restrain D.C.’s bottomless thirst for spending. Because of the debt limit, House Republicans were able to force the White House to the negotiating table and extract modest concessions in the form of the Fiscal Responsibility Act. While the FRA reduces decade-out debt by only 4 percent of GDP, it’s better than nothing, and it’s hopefully just a start. Without the debt limit, it would be much harder to exert any fiscal restraint at all. Amazingly, Treasury Secretary Janet Yellen’s response to
Fitch claims credit on behalf of the Biden administration for the FRA’s “deficit reduction . . . improving our fiscal trajectory,” when she and the White House insisted on no spending cuts and came to the negotiating table only under threat of default.
The downgrade makes obvious the urgency with which we must start putting our nation’s finances on a more secure path. While there’s some very low-hanging fruit — for example, repealing and maybe even clawing back some of the unnecessary fiscal
stimulus in the so-called Inflation Reduction Act — there are other, more difficult choices to make, especially regarding entitlement reform. Without putting Social Security, Medicare, and Medicaid on more durable long-term paths, no plausible cuts to discretionary spending will save the long-term budget outlook. And given lingering inflation pressures and the risk of financial instability induced by the fastest monetary-
tightening cycle in history, now is an opportune moment to engage in fiscal retrenchment and reduce interest rates, resulting in a much better mix of macroeconomic policies that will deliver lower inflation, a sustainable long-term budget
path, and stabler financial markets.
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