Fiscal Trap?


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.”

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  1. Profile Photo Inactive

    When people reach their credit card limit, they can either decide that the limit was not high enough to start with, and work to raise it, after the fact, or they can decide to live much more modestly, and pay off their debts. Honorable people do the later. Reckless Democrats (is there any other kind?) do the former.

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  2. Profile Photo Coolidge

    I am woefully ingnorant on economics. What is “quantitative easing”?

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  3. Profile Photo Coolidge

    Ok, I sort of get it now:

    In the word’s of Al “It’s like printing my own money!”

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  4. Profile Photo Contributor

    Underscoring the severity of the problem, take a look at the yield numbers for US sovereign debt. Short-term debt has been essentially free during the Obama administration–even today one-year T-bills yield a paltry 0.28%–but the growing mountain of accumulating deficits must be refinanced with regularity. . . and rates are rising in response to QE2.

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  5. Profile Photo Member

    This is just the latest QE scheme Bernanke has floated since 2006, all in the name of staving off deflation. This one is targeted at boosting bank reserves to juice lending, a gift to the banks (which banks? how selected?). As a small business owner, my last source of ready credit dried up 17 months ago, and others I talk to are in the same boat. Lenders don’t like the terms Obama forced on them when he took office and they have seen the wages of caving on their lending standards in the face of threats from politicians with the housing bubble.

    If I lend under Obama and the Dem Congress, I accept these folks as my landing partner, changing the terms of my contract agreements with borrowers on a whim, checking the color and accent of my borrowers to make sure that credit-worthiness is no longer a priority.

    The good news is that, unless the banks actually lend the money, the inflationary effect is minimal.

    Were Bernanke to succeed in pumping up inflation, he might actually convince the countries who use the dollar as their reserve currency to transition elsewhere, creating and inflationary surplus in domestic supply.

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  6. Profile Photo Inactive

    This helped me some.

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  7. Profile Photo Member

    If you think Bernanke doesn’t consider higher interest rates–even a bond market scare–as an “acceptable downside”, think again.

    Historically, central banks in the Fed’s position welcome any pressures for their government to stop borrowing so much, to bring the current account deficit (trade deficit) down to an acceptable level.

    They will try boosting exports, raising inflation expectations, higher inflation–but in the end, if all else fails, I suspect Bernanke will willingly push Congress off the fiscal cliff (the Fed said it wasn’t going to “rebalance the world,” and world leaders needed to work together. . .in 2005. I get the feeling they may have reconsidered that position.)

    [edit] to be clear, a balanced U.S. budget would do wonders for global rebalancing. Another recent tactic is reversing global capital flows, forcing real exchange rates in Asian nations to rise (e.g. China’s inflation rate is 3% higher then ours, which is the same as the currency appreciating 3% (a year) faster then it already is).

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  8. Profile Photo Inactive

    Loss of confidence in the dollar? When the Euro began it was 1-1 parity with the dollar. It procceeded to sink to the $.85ish level as I recall, and then began a gradual climb to $1.31 today. The dollar ranged from 110Yen – 120Yen for years and now stands at 84Yen/$1.

    Keep in mind that the Euro today has a financial meltdown in three countries and Spain is strongly suspect………with Italy a suspected question mark. Japan has one of the most absurd debt situations in the developed world coupled with a demographic time bomb.

    I would say the the loss of confidence is coming at warp speed.

    Even versus developing countries like the Philippine Peso – I bought some properties there 6ish years ago when the peso stood at P55/$1, today it is at $1 – 44pesos. When the peso looks stronger than the dollar, batten down the hatches!

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  9. Profile Photo Inactive
    Ken Owsley: Ok, I sort of get it now:

    In the word’s of Al “It’s like printing my own money!” · Nov 28 at 8:05am

    Quantitative Easing is like treating a patient with bladder control problems to a garden hose in their mouth and the tap turned on full.

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