There is a memorable line in Ernest Hemingway’s book “The Sun Also Rises,” where a character says. “How did you go bankrupt?” The second person replies, “Two ways, gradually, then suddenly.”
The response provides potent imagery for America’s debt problem. Each day we borrow more, and our debt rises. We are doing fine now — low inflation, low interest rates and full employment. But there’s more to the story. Bad things happen gradually before they happen suddenly.
This, in a nutshell, is America’s borrowing problem.
The deficit — which measures the amount by which the U.S. government’s total budget outlays exceed total receipts for a fiscal year — tallied $779 billion in fiscal year 2018. It will surpass $1 trillion this fiscal year. Even more sobering, it’s grown in each of the past three years despite the U.S. economy’s strong performance and Republican leadership in Congress and the White House. We now face a total debt held by the public of approximately $16.1 trillion. To pay that debt back every man, woman and child in the United States would need to transfer approximately $50,000 to the U.S. treasury.
I recently attended a dinner with three former senior state and federal policymakers. It was a social setting, but we still talked about the issues. One asked the question: “What is the single biggest problem facing our country?” Almost in unison we looked at each other and said, “the debt.” The unity of response sounded an alarm inside me. The conversation then turned to the risks we face as a major geopolitical foe holds more than one in every four dollars of U.S. Treasury bills owned in foreign countries.
Economists view the debt challenge in terms of a concept known as “crowding out.” When debt rises, interest payments become a larger and larger portion of the budget. This crowds out other spending important to national well-being, such as investment in bridges, roads, education, research and development and health care.
Should we require our children, grandchildren, great grandchildren and more to pay for our consumption during the longest economic expansion on record?
Another form of crowding out occurs when public borrowing squeezes out private borrowing. Higher government debt increases the demand for available funds and raises interest rates. Fewer available funds and higher rates make it more difficult for businesses and individuals to secure funds to invest in housing, education, factories, equipment and training. Productivity and living standards suffer. In the Hemingway imagery, this is the “going broke gradually” risk.
The “going broke suddenly” risk takes the form of a full out financial crisis. Imagine a scenario where debtholders lose confidence in their investment. This would trigger a rapid sell-off of government bonds. Capital would flee the country and the U.S. budget situation would deteriorate rapidly.
As persuasive as I find these economic principles, the moral argument may be even more compelling. Should we require our children, grandchildren, great grandchildren and more to pay for our consumption during the longest economic expansion on record?
Some argue that we can keep borrowing as long as interest rates are lower than the economy’s rate of growth. Prominent U.S. economist Larry Summers falls into this camp. Summers recently wrote in Foreign Affairs (Jan. 27, 2019), “Deficits … should not cause policymakers much concern, at least for now.” He points out that low interest rates make it so governments can sustain higher levels of debt because financing costs are lower. He points out that even though the national debt represents a larger percentage of our economy than in recent decades, we continue to pay about the same proportion of interest to GDP as in recent decades.
But what happens when interest rates change?
Optimal fiscal policy belongs on the side of caution. I don’t argue for extreme fiscal austerity, nor explosive deficit spending. I do argue that in a time of economic expansion, we should be borrowing less. We should be calling upon our national leaders to lead on this important issue. Let’s not go bankrupt gradually or suddenly.