Fear the Spending, Not the Debt

Never underestimate the ability of politicians to mess up a good thing. They're certainly trying in Washington, D.C.

Unfortunately, many people are concerned about the wrong thing. Nice even numbers fascinate people, and through the first eleven months of this fiscal year (October 2018 through August 2019), the U.S. budget deficit was over $1 trillion ($1.067 trillion to be exact), up 19% versus the same eleven months the year before. The government usually runs a surplus in September, so the budget deficit for full Fiscal Year 2019 should come in at roughly $950 billion – that's close enough to $1 trillion for government work.

Meanwhile, the public debt is at a record high $22.5 trillion, and the Congressional Budget Office projects roughly $1 trillion annual deficits as far as the eye can see. So, it's easy to understand why so many are concerned. Some even think the US is headed for bankruptcy. And, unlike with Greece, there's no one big enough to bail-out the US.

Here's what they're missing: in spite of record debt, the net interest on the debt should finish the year at 1.8% of GDP. For perspective, that's lower than it ever was from 1980 through 2001, during which it averaged 2.7% of GDP – and some of those years saw budget surpluses.

Moreover, net interest relative to GDP is unlikely to rise dramatically anytime soon. Imagine we wake up tomorrow morning and Treasury yields are miraculously at 4.0% across the entire yield curve, from short-term securities to long. That would be well above the 2.5% average interest rate taxpayers already pay on all marketable Treasury debt outstanding, including the securities issued many years ago.

Moving from 2.5% to 4.0% is a 60% increase in interest costs, which also means that, once we roll-over enough debt, the interest burden relative to GDP would rise by 60%, as well. But a 60% increase from 1.8% of GDP, would put us at 2.9%, very close to the long-term average in the 1980s and 1990s. And, interest rates aren't going to 4% in the real world anytime soon, plus it takes time for the debt to rollover.

The Treasury Department could use the current era of low long-term interest rates to lengthen the maturity of the debt. The best idea we've seen is for the Treasury to issue perpetual inflation-indexed debt and then step aside and let the private sector slice and dice these instruments into bespoke securities. The market could create everything from plain vanilla 10-year Treasury notes, to 50-year zero-coupon debt, to debt instruments that don't pay interest for the first twelve and a half years and then pay every six months after that.