Sometime in early 2018, this commentary broached the idea that the winter of fiscal “responsibility” (if one can use that word for $400 billion deficits) had abated in Washington, and a new spirit of deficit spending had begun to sprout. By now, the zeitgeist has altered so completely that politicians and pundits can now speak of trillion dollar annual deficits without shame or fear. This era of fiscal profligacy can be summed up in the acronym WHAT?—What’s Another Trillion? Of course, many of those embracing this new attitude were only a few years ago bemoaning the deficit and the unspecified but severe damage it would wreak upon our children and grandchildren. But never fear—the cycle will turn one day and the same characters will be decrying the “train wreck” of entitlements and attempting to cut our Social Security benefits.
There’s debt, and then there’s Debt
We have in the past examined (perhaps at too great a length) the different measures of federal debt. Generally speaking, the “real” federal debt is referred to as Debt Held by the Public. And while the total federal debt has been increasing, debt held by the public has been growing at an even faster rate, and its percentage of the total debt has jumped from 57% in 2001 to 73% in 2018.
You can think of intergovernmental debt as the recognition that some monies have been collected and/or allocated in advance for future obligations. The “trust funds” are simply accounting vehicles and debt “owed” to them is not money that needs to be repaid to an outside entity. This is not to say that we can ignore intergovernmental debt or that it is meaningless. But as a debt which needs to be managed—auctioned off and interest paid on—it is not.
Debt held by the public, on the other hand, must be sold and serviced in the financial markets. It is the stuff that will get us into trouble, if trouble is to be had through the national debt. Debt held by the public has been growing faster than the total debt because Social Security tax collections, which used to be a surplus, now roughly match distributions. This means the Social Security Trust Fund, which is the largest component of the intergovernmental funds, has stopped growing and will begin to creep lower in the future.
In the past, bull markets and good economic times (late nineties, 2004-07) saw the debt to GDP ratio fall or at least flatten. During those periods, improved tax receipts lowered the annual deficit while growth moved GDP higher. In the last five years, however, a stock market rally and falling unemployment have not substantially reduced the deficit, and the recent tax changes promise an expanding deficit even in good times. A garden-variety recession with flat GDP and tax receipts would wrench the curve higher, and one can only imagine what a downturn like 2008-11 would do to the debt/GDP ratio now.
Why does it matter? Not because the federal government will “go broke” or even that fiscal pressures will force hard choices on Congress (We will tackle this in a later commentary). Rather, a ballooning debt to GDP ratio means that returning to a “normal” (pre-2000) interest rate structure (4-5% short rates and 5-6% long rates) will put enormous pressure on the budget and therefore will be extremely difficult for the Fed to impose. (Recently we have seen certain parties blame a slight pullback in the equity markets on the Fed and its “crazy-high” interest rates with short-term rates at 2.5%–one can only imagine the spluttering that would ensue at a 4% rate.) If inflation does begin to increase the Fed will be between a rock and a hard place, including the unpleasant possibility that both higher and lower rates might lead to price inflation.
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