In the current issue of The Weekly Standard, there is a sobering article by Lawrence B. Lindsey on the potential consequences of quantitative easing. Ben Bernanke fears deflation, wants to goose the economy, and professes not to mind if inflation returns to the recent norm. Lindsey explains in detail what that would mean with regard to our ability to service the national debt. On his reckoning – even if we assume that married couples making over $250,000 will be saddled with a significant tax increase next year, even if something modest is done to reduce federal spending – this means that, whereas we are paying $200 billion now in interest on the national debt, we will be paying $847 billion in 2015 and $1.5 trillion in 2019.
The increase in annual interest costs in 2015 alone—$557 billion—is nearly six times the additional revenue that is supposed to be collected by letting the higher end of the Bush tax cuts expire, the centerpiece of the current fiscal policy debate in Washington. The increase in interest costs in 2019—$795 billion—is two-and-a-half times the value of all the Bush income tax cuts of 2001 and 2003 that are due to expire. On the spending side, just the extra interest cost from a quantitative easing “success” would swamp, say, the entire defense budget for the rest of the decade. No plausible increase in taxes or reduction in spending could fill a gap of that magnitude.
Interest rates could also rise for a variety of other reasons. Much faster real economic growth could have the same effect. An additional point of real growth for five straight years would help by raising revenue by about $450 billion over five years, but a parallel increase in real rates would raise interest costs by $700 billion over the same period. The higher real rates and larger deficit would likely put a lid on the sustainability of any growth spurt. Alternatively, an increase in borrowing costs caused by international creditors’ demanding higher real yields is also possible. One of the leading possible causes of such a rate spike would be a loss of faith in the dollar as creditors could demand higher yields to offset currency depreciation.
In short, we are in a pickle – comparable to that of Japan over the last two decades. As Lindsey puts it, “unless we get control of the deficit, quantitative easing will eventually lead to higher inflation or a loss of confidence in the dollar, or both. At that point, the resulting higher borrowing costs will swamp any of the current supposedly dramatic deficit reduction plans that are on the table.”