The federal deficit has become a front-page issue. The deficit was recently running at an amount equal to 15% of GDP per year — even before the Biden spending proposals. They are the highest deficits as a share of income for decades. These deficits generate a need for more taxes, so the Treasury Secretary recently suggested an increase in corporate tax rates as a starter.
It didn’t get very far, as that would make US corporate tax rates higher than those of some overseas tax havens. So as long as Ireland exists, it will be counterproductive to raise US corporate tax rates, just as it has all across the EU. Corporations, more easily than people, can move their domicile for tax purposes.
Other tax hikes will be considered, but the most immediate option to obtain the funding for the planned federal spending is to sell more US sovereign debt. And that is the rub. It’s not just that the total amount of US debt relative to income is high (more than 100%), but the rate of growth at the margin is accelerating.
Pity Janet Yellen. As Secretary of the Treasury, she will be seeking buyers of US bonds in the trillions of dollars, not just to cover this year’s deficit but also federal debt incurred years back that is set to mature this coming year.
Running federal deficits has apparently become an American tradition, as there has been net federal debt issuance with every president since Calvin Coolidge — that is, for the last 100 years. Sometimes the deficit spending was incurred as the result of actual wartime finance, or financing a war on Covid. More recently, the rationale for deficit spending has been rooted in the unquestioned Keynesian notion that if the economy needs a politically motivated shot in the arm, deficit-financed government spending is the go-to solution.
And with this mind set, there are Biden proposals for infrastructure, and the American family on top of an additional Covid bill.
What started as a theory 75 years ago has now become the go-to band aid for a slowed economy, without any consideration of how the debt created in this process can itself slow the economy. And that’s what debt in these quantities ultimately does.
That part of Keynesianism regrettably did not make it into the textbooks. American consumers living on personally financed borrowed money seem to have a better understanding of debt accumulation than politicians do. But voters and their inclination to be debt free have been taken out of the equation of resistance to federal debt as they have been coopeted. Joe Biden did learn something in his 42 years in Congress: you can eliminate voter resistance to government spending and deficits by sending them a check with the proceeds.
The textbook economics that many citizens took in college has given way to the textbook political economics of parceling out goodies to control the hearts and minds of voters in these matters.
To pull this off requires a willingness to borrow funds in the name of the US government (in effect, the taxpayers). And taxpayers do not put up much of a fight because they, in turn, have become recipients of green US Treasury checks delivered directly to their bank accounts without even the inconvenience of having to deposit the check.
As government bonds has funded the green Treasury checks, virtually all political resistance to spending, has dissolved for now.
In turn, many recipients of federal checks are increasingly taking themselves out of the labor market, as their bills have been covered by Uncle Sam. So, the problem going forward is labor scarcity rather than unemployment.
This ultimately shows up in the form of higher wages and higher prices, as long as the demand side of goods markets is being buttressed by the deficit-financed spending. So as Janet looks to sell the bonds to fund these programs, she will run into the dual headwinds of perceived inflation risk and sovereign risk that deter bond buying.
In turn, reduced demand for bonds will result in lower prices and higher interest rates for bonds which in turn reduce the total return especially on long term government bonds. The bond market pays close attention to this and it deters future willingness to buy and hold US Treasury securities.
This is no longer a perspective concern for the Treasury Department as the Financial Times reports that in the first quarter of this year, the total return on long duration US bonds (ten years or more) was not just negative at -13.5% but the largest quarterly decline in total return since the inflationary l970s (https://www.ft.com/content/c7107a3b-483d-4c6f-80c1-1f555ac38a97).
While at this point, inflation has not yet materialized significantly in the official numbers, but inflation expectations have indeed moved upward which accounts for the fall in the market prices of previously issued fixed rate bonds. These risks, will reduce enthusiasm for those bonds so it’s becoming a rational issue of whether the bond market will indeed provide the funding for the Biden proposals at previously low interest rates even if the legislation is passed by Congress.
Additionally, don’t expect the tendency for higher yields from inflation and sovereign risk to be charged only on the net additional debt from the Biden proposals. Higher US interest costs will trickle down to all previously issued debt when refinanced after reaching maturity.
Since the average maturity on Treasury debt is just 6.5 years, this means it takes only about half a decade for past debt holders to be additionally rewarded with both inflation and sovereign risk premiums when refinanced at tomorrow’s rates.
It’s been a long time since we have been here where there will be questions about the ability of the US Treasury to fund these proposed spending programs. Meanwhile, keep your eye out for the results of the weekly bond auctions to see if bond buyers are turning away from US debt,
When consumers over-indebt themselves, they expect to be turned away from future loan requests and they realize they must devote a larger share of future income to work-off past incurred debt. The same tendencies will affect the government and the macro-economy. Biden and his staff show little understanding of this, but let’s hope the voters do.
Quite simply, past debt is a tax on future net income. Incidentally, in case you are wondering, US debt on a per capita basis is conservatively estimated to be $70,000, or $280,00 for a family of 4. If voters get the eerie feeling that some day they will be asked to pay-off their proportional share. If that occurs, the politics of government spending will turn on a dime. All it takes is some member of Congress to introduce such a bill for the freight to set in.
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Sample of the Reaction From: John Mauldin’s Thoughts from the Frontline May 1. 2021 entitled: Federal Government Debt
“We’re going to run, this year, well over a trillion in off-budget deficit spending and trillions more in the regular budget deficit. We’re going to be $40 trillion in debt by 2025. That’s 180% debt to GDP. That looks like Japan and Europe.”