Interest Rate Roundup

Monday, October 20, 2008

New York Times: Budget Deficit? Who cares!

The New York Times has a good story today about how the U.S. is on track to run up the biggest budget deficit in history this year. Yet no one in Congress -- or large swaths of the private sector -- cares. America is largely betting that foreign investors will continue to be content with lending us hundreds of billions of dollars of cheap money at rock-bottom Treasury rates. Only time will tell whether that turns out to be a good bet. More below ...

"The Congressional Budget Office estimates that the deficit in the current fiscal year, which started this month, will reach roughly $700 billion, up more than 50 percent from the previous year. Measured as a percentage of all the nation’s economic activity, the deficit, at 5 percent, would rival those of the early 1980s, when a severe recession combined with stepped-up federal spending and Reagan-era tax cuts resulted in huge budget shortfalls.

"Resorting to credit has long been the American solution for dealing with expensive crises — as long as the solution has wide public support. Fighting World War II certainly had that support. Even now many Americans tolerate running up the deficit to pay for the wars in Iraq and Afghanistan, which cost $11 billion a month combined. And so far there is wide support for an initial outlay of at least $250 billion for a rescue of the financial system, if that will stabilize banks and prevent a calamitous recession.

“There are extreme circumstances when a larger national debt is accepted as the lesser of two evils,” said Robert J. Barbera, chief economist at the Investment Technology Group, a research and trading firm.

"There are also assumptions that help to make America’s deficits tolerable, even logical. One is that people all over the world are willing, even eager, to lend to the United States, confident that the world’s most powerful nation will always repay on time, whatever its current difficulties.

“So far the market is showing that it is quite willing to finance our needs,” said Stephen S. McMillin, deputy director of the White House Office of Management and Budget.

"Lenders are accepting interest rates of 4 percent or less, often much less, to buy what they consider super-safe American debt in the form of Treasury securities. The 4 percent rate means that the annual cost of borrowing an extra $1 trillion is $40 billion, a modest sum in a nearly $14 trillion economy, helping to explain why the current growing deficit has encountered little political resistance so far.

"But if recent history repeats itself, the deficit is likely to be an issue again when the economy recovers.

"Interest rates typically rise during a recovery, so the low cost of servicing the nation’s debt will not last — unless a recession set off by the banking crisis endures, repeating the Japanese experience in the 1990s and perhaps even stripping the United States and the dollar of their pre-eminent status.

"The assumption is that will not happen, and as the economy recovers, the private sector will step up its demand for credit, making interest rates rise.

"Higher rates in turn would increase the cost of financing the deficit, and there would probably be more pressure to reduce it through cuts in spending. That happened in the late 1980s, as Congress and the White House coped with the swollen Reagan deficits. The Gramm-Rudman-Hollings Act, with its attempt to put a ceiling on deficits, came out of this period."


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