In a Sixty Minutes interview yesterday, Fed Chairman Powell mentioned the elephant in the federal fiscal policy room–that national debt is high, and growing faster than the economy. Therefore, at some point (not tomorrow, but relatively soon–ten years from now, one prominent NY bank is speculating) potential government bond buyers will begin to view the situation as unsustainable.
The resulting government funding crisis can develop in one of two ways:
- the Treasury wakes up one day and finds it has no money to pay the national bills, or
2. buyers of long-dated Treasuries wake up one day, realize this nightmare possibility is only a few years off and decide they don’t want to be holding Treasuries when that happens. So they either demand much higher interest rates to compensate for this extra risk, accelerating the journey to potential insolvency–or they just don’t buy long-dated Treasuries at all.
Assuming MAGA is in the rearview mirror by then, the second is much more likely than the first.
The analyses I’ve read argue that that foreign buyers, who face the extra worry of currency risk as well as interest rate/repayment risk, will be the first to shun US debt. My recollection of the bond crisis of the mid-1980s, though, is that it didn’t happen that way back then. Rather, it was the most savvy traders in Treasuries–American bond portfolio managers–who started the stampede away from Treasuries. I don’t see any reason why it wouldn’t be the same again.
This continual failure to balance government budgets isn’t really a partisan issue, in my view, even though economically semi-literate Republicans seem to me to be behind the deficits in Washington. Any observer of the slowly evolving crisis in Democratic state worker pensions plan funding–think: Calpers or its siblings in California–will likely attest to this. The highest level of magical thinking in budget matters, I think, has its roots in the Reagan/Thatcher Revolution of almost a half-century ago.
Its two basic axioms:
—there’s no such thing as a public good. The neoconservative argument is that if governments withdraw from any area of public interest–say, building roads or providing schools, or medical or retirement benefits, private entities will spring up to take their place, and will provide better service at lower cost. Yes, it’s true that the corporate raiders of the 1980s did force much of American industry to modernize to be able to compete with newly-rebuilt Europe and Japan. But that was well over a quarter-century ago. The US is now the laughing stock of the developed world because of our decrepit transportation and communications infrastructure. And it will be interesting to see how the electricity grid holds up as we shift to EVs.
–-trickle-down economics. This is the idea that tax cuts for the wealthy puts money into the hands of people who will spend most/all/more than all of it–spurring overall economic growth. The reality is the opposite–the wealthy have the lowest marginal propensity to consume, meaning that from an overall macroeconomic point of view, they’re the worst people to give stimulus money to. Highest increase in contributions to political campaigns, maybe, but overall the worst.
It’s not obvious that either of these makes economic sense today, even though they may have been more appropriate in the days right after WWII. Right or wrong back then, with the trend real growth rate of the US economy having dropped from 3%+ in the 1980s to 1%- today, the Reagan/Thatcher approach hasn’t been the panacea that one initially had hoped for. Of course, the aging of the working population and the falloff in overall business innovation (which is closely linked to how good the education system is) both play a role in the slowdown.
The curious–and interesting–part of all this is not that politicians continue to double down on these policies, apparently arguing to themselves that if they do the same (loony) thing enough times they’ll get different results. It’s that the Chairman of the Board of Governors of the Fed, Jerome Powell, who typically keeps a low profile, mentioned on TV his (100% correct view, as I see it) that the strategy of running chronic government deficits in the expectation that it will create strong future GDP growth is now in an increasingly risky stage.
What could happen? My initial impulse is to think of Japan–a moribund economy, huge government debt and a currency that has collapsed. But I don’t think that’s right. In Japan’s case domestic savers, individual and institutional, are a bulwark of support for government bonds. The proven reluctance of US savers to go down with the ship suggests that under current policy Japan is most likely an aspirational goal.