Does National Debt Still Matter? America's Greatest Gamble
Fiscal hawks have been sounding the alarm about rising debt levels for decades, but their nightmare scenario of runaway inflation hasn't come to pass. How do we know if this time is different?
In 2010, when former White House Chief of Staff Erskine Bowles and former Sen. Alan Simpson (R–Wyo.) were appointed to co-chair President Obama's deficit-reduction commission, the Congressional Budget Office (CBO) offered two projections on the future of American debt. One forecast saw debt ballooning, and the second was much more moderate. Current projections are somewhere in the middle.
And in the 11 years since, America has also made no meaningful structural reforms to deal with the problem.
Congress has doled out more than $4 trillion in response to the COVID-19 pandemic. The U.S. national debt held by the public is currently almost $22 trillion, or about $67,000 per citizen, surpassing the country's annual GDP for the first time since World War II.
On the current path, the CBO predicted in March that the debt would grow to 102 percent of GDP by the end of 2021, to 107 percent by 2031, and 202 percent by 2051. It also predicted that by 2051, the federal government will be spending more than a quarter of its annual budget just to pay interest on the principal. But those estimates came before President Joe Biden signed the $1.9 trillion COVID-19 relief bill, which made the long-term budget outlook even worse.
What is the risk to the U.S. economy? Fiscal hawks have been sounding the alarm about rising debt levels for decades, but their nightmare scenario of runaway inflation hasn't come to pass. How do we know if this time is different?
In 2010, midway through the first term of President Barack Obama and on the heels of the Great Recession, the national debt was skyrocketing. It had exploded under President George W. Bush, who engaged the U.S. in two foreign wars and expanded eldercare entitlements, which are the biggest drivers of U.S. debt. Bush had the full backing of Republicans in Congress. Under his watch, the U.S. also bailed out big banks and entire industries. But it wasn't until a Democratic president championed an $831 billion federal stimulus that Republicans said they had finally seen enough.
The Tea Party rose to prominence, riding a wave of public concern over debt levels that they said would hinder economic progress and stick future generations with the bill. Republicans claimed to be renewing their commitment to fiscal responsibility post-Bush. After Democrats were walloped in the midterm elections, President Obama established the Simpson-Bowles Commission, which concluded that disaster was inevitable unless the federal government cut spending, raised taxes, and reformed entitlements. The commission's recommendations were never adopted. Its critics say that that's a good thing.
"If the Simpson-Bowles had been adopted, we would have been chronically short of demand in the years that followed its adoption," Jason Furman, who chaired the Council of Economic Advisers under President Obama, tells Reason.
"The unemployment rate would have been higher, growth would have been lower, and when we went into the COVID crisis we would have gone in with a lower inflation rate, lower interest rates, and thus, even less scope to maneuver than we actually had," Furman says.
Furman has co-authored a paper with his Harvard colleague and former Treasury Secretary Lawrence Summers questioning past assumptions about the national debt. He says that the debt hawks of the 2010s were wrong to worry that America's balance sheet endangered the economy.
As the industrialized world racked up debt through the 2010s, inflation and interest rates stayed low—contrary to the warnings of the doomsayers.
This situation, Furman and Summers say, implies that the U.S. government has much more leeway to borrow money, spend it on government projects, and grow its way out of the debt than fiscal hawks have led us to believe. Furman argues that the story is much the same regarding the pandemic-era economy.
"There was nothing about the U.S. debt level going into the COVID crisis that created any constraint on the resources available to fight the crisis," he says. "The United States was able to borrow an enormous amount, [and] not just the United States. Japan, which has a higher debt level, was able to borrow an enormous amount." According to Furman, there is no relationship between a country's debt and its ability to manage the COVID crisis.
John Cochrane, an economist at Stanford University's Hoover Institution, disagrees. "If you wait until the crisis comes, everything is much much worse," he says.
As a fiscal hawk, Cochrane acknowledges that his doomsaying has been wrong for the past decade, but he says that doesn't mean he's wrong now.
"I live in California. We live on earthquake faults." Cochrane says. "We haven't had a major earthquake, a magnitude nine, for about a hundred years." It would be foolish to consider someone a doomsayer for preparing for an earthquake in California, he says, despite the fact that major earthquakes aren't a common occurrence.
"That's the nature of the danger that faces us. It's not a slow predictable thing," says Cochrane. "It is the danger of a crisis breaking out. So I'm happy to be wrong for a while, but that doesn't mean that the earthquake fault is not under us and growing bigger as we speak."
Economist and New York Times columnist Paul Krugman wrote in a December piece titled "Learn to Stop Worrying and Love Debt" that, "It's a completely safe prediction that once Joe Biden is sworn in, we will once again hear lots of righteous Republican ranting about the evils of borrowing."
Krugman is right. Republicans have been complicit in ballooning the debt going back to the Nixon administration. But scoring rhetorical points about GOP hypocrisy doesn't address the question of whether or not America's debt, typically measured as a ratio of GDP, is cause for concern. The U.S. reached these heights only once before—at the end of World War II.
"The U.S. had a hundred percent debt-to-GDP ratio because we borrowed a ton of money to save the world from fascism," Cochrane says. But he argues that today's situation is different because the U.S. stopped spending after World War II.
"The war was over and the U.S. ran steady primary surpluses, actually. Whereas right now, we're talking about at least three to five percent primary deficits forever. Plus stimulus for crisis. Plus Social Security and Medicare," Cochrane says.
But Furman and Summers say that if the government spends money borrowed at low-interest rates on critical infrastructure, it will more than pay for itself in the long run.
"If it costs you…zero to borrow and something does more than zero, it's worth doing," says Furman. "It then needs to do a decent amount more than zero such that when you tax it…it pays itself back." Furman claims that the expenditures that do this are limited, but says that the evidence points to the value of investing in children in areas like preschool and child health care.
Cochrane agrees that government spending on certain projects theoretically can boost growth, but he is skeptical of the government's ability to spend the money wisely.
"None of the current stimulus payments are going towards things that raise the economy's long-run growth path," says Cochrane.
He claims that most of the money spent on COVID-19 relief won't help the economy's long-range prospects—and he's not sure Biden's $2.25 trillion for proposed infrastructure spending will, either.
"Our government is not very good right now at investing wisely in things that are good projects," Cochrane says. "Let me point to the California high-speed train for example. It's going to connect Fresno to Bakersfield at about 60 miles an hour at a cost of $80 billion and has not one mile of track has been built yet. That's the kind of infrastructure our government tends to [build]."
Money for high-speed rail was part of the 2009 $831 billion federal stimulus package. Summers, Obama's chief economic adviser at the time, called it a targeted, temporary, and timely boost to the economy that would focus on "shovel-ready" infrastructure projects. But the stimulus package failed to stop civilian unemployment from rising to 10 percent, the construction workforce from contracting by more than 14 percent, and the economy from shedding more than 7 million jobs in Obama's first term.
The Obama administration promised that 90 percent of the jobs supported by the act would be in the private sector. A year after the law's implementation, four out of five positions created were government jobs. Each job the stimulus package created cost taxpayers between $100,000 and $400,000, according to a study by two Dartmouth economists.
Some economists, including Paul Krugman, said that the 2009 stimulus didn't work because it was too small. Today's $4.1 trillion in pandemic-related spending is a test of this theory. It is an unprecedented sum. In current dollars, it is equivalent to what the federal government spent both to land a man on the moon and to build the entire interstate highway system—multiplied by 5. And that doesn't include the Biden administration's proposed $2.25 trillion in infrastructure spending.
Summers recently expressed concern that inflation actually could be a problem after the U.S. spends trillions on fiscal stimulus.
"There's a real possibility that, within the year, we're going to be dealing with the most serious incipient inflation problem that we have faced in the last 40 years," Summers said in an interview with Bloomberg in February.
Furman believes that more stimulus money was allocated in 2021 than was warranted. He says that he would have preferred to have the payments more spread out over time.
"I think the number could have been even larger if it had been spread out over time," says Furman. "So I don't think it was optimally designed from an economic perspective. I think it creates some risks but I don't think that those risks are huge. I think [that] on balance it's more likely that the higher inflation is good than that the higher inflation is bad."
Furman and Summers' paper also expresses concerns about debt projections beyond 2030 absent Social Security and Medicare reform as baby boomers retire en masse. Simpson and Bowles recognized that the bill on eldercare would eventually be the item to bust the budget.
"All else equal, addressing entitlements sooner is better than addressing entitlements later," Furman says. "If you want to address it more on benefit reduction, then you probably do want an earlier start, I'm comfortable doing it on the tax side. I understand others probably want to do it on the benefits side. And if I were them, I'd want to get started sooner too."
The libertarian economist Murray Rothbard once wrote that when economists started telling politicians that it was the "government's moral and scientific duty to spend, spend, and spend," they went from being the "grouches at the picnic" to in-house yes-men.
Furman says that unlike advocates of Modern Monetary Theory, which posits that near-unlimited government money creation and spending are possible without dire consequences, he recognizes that there are limits. But he believes we are using the wrong metric to gauge the magnitude of the problem.
"The question is where do you want to stabilize the debt," says Furman. "People used to think it should be 30 percent of GDP. Is that what we need to do in order to be safe? I think if you're asking that question without looking at interest rates, then you're in danger of a very incomplete answer."
"Most people acknowledge that there are limits but they envision slow, steady warnings. That you'll see the problem coming and you'll have plenty of time to fix things," says Cochrane. "And I looked through history and I noticed that when things go wrong, they go wrong in a big crisis."
Cochrane says he's worried that debt will be a drag on economic growth, but he's especially concerned that the U.S. could face a scenario similar to the sovereign debt crisis that hit Greece in 2010, which caused its economy to shrink by a quarter, and unemployment to climb to 25 percent. Greece's position was admittedly different, but the country's meltdown shows the social and political consequences of a fiscal crisis. The state seized assets; banks limited ATM withdrawals; there were food lines, anti-austerity protests, and violence; and extremist political parties gained ground.
Cochrane says that if a debt crisis like that of Greece hits the U.S., it would be an unimaginable catastrophe. Greece at least had Germany to bail them out, while there is no one to bail out the U.S.
"Governments that are undergoing a debt crisis grab money everywhere they can. So watch your wallet," Cochrane says. "All those things that you count on coming from the government disappear. All of a sudden taxes go up very sharply…Basically, say goodbye to your wealth."
Yet Cochrane believes it is not too late to avert a potential crisis and that the U.S. can look to other countries as examples to follow. He says that in the 1990s, Sweden "recognized that socialism wasn't working" and reformed its social welfare system. As a result, its economy grew.
"It's straightforward to do as economics. Functioning democracies are able to get together and see problems coming and fix them," Cochrane says. "We have been able to do so in the past… let us hope that we can do so before it's too late."
Cochrane says that in the meantime, if there's no political will to cut spending and slow down borrowing, Treasury Secretary Janet Yellen should "borrow long" by taking a slightly higher interest rate for a longer-term loan.
"Then in the event of trouble, we don't have to pay more interest on the outstanding debt. And that really diffuses the crisis mechanics," says Cochrane. "Are you going to be so greedy that you're not going to pay one and a half percent interest rates in order to get rid of the possibility of a debt crisis for a generation? It seems like cheap insurance to me."
Is there a point where taking on too much debt is an unacceptable risk?
"The United States isn't going to default on its debt. We borrow in our own currency. So there's zero default risk," says Furman. "There is definitely inflation risk if you borrow too much and can't pay it off, but it's not like you go from one and a half percent inflation to hyperinflation in the blink of an eye. There's a lot of steps between here and there. I think there is certainly some risk and in the event that that risk materializes we will have to, very quickly, sit down and figure out how to raise taxes or cut spending."
Cochrane has a different perspective.
"Things always go boom all of a sudden, and so the key to fiscal management is to keep some dry powder around to have some ability to be able to borrow more," Cochrane says. "Imagine if world war breaks out, and we've already borrowed the 100 percent debt-to-GDP ratio that we ended World War II with. Well, once we're at a 100, 150, 200, our ability to meet that next crisis with borrowing is gone and then that next crisis is a catastrophe."
Produced by Zach Weissmueller and Justin Monticello. Graphics by Lex Villena and Isaac Reese.
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