Building on my post from last week about the cost of our debt, I have made this chart showing the changes that will occur when the Congressional Budget Office’s interest-rate assumptions are modified to reflect historical interest rates and private-sector forecasts.
This suggests that CBO baseline projections, which already show an explosion in the cost of servicing our debt, may in fact be an underestimate.
For instance, if interest rates were modified to reflect the average rates in the 1980s — a time in U.S. history when interest rates were driven up by inflation and economic uncertainty — in 2021 our interest payments would nearly triple from CBO’s projection of $749 billion to $2.0 trillion. Accumulated interest payments over this period would double from their current projected level of $5.7 trillion to $11.0 trillion. Needless to say, the impact of these increased interest costs on the deficit would be huge.
That is precisely the game the U.S. is playing right now. We are constantly rolling over short-term debt. When our lenders wise up, they are likely to increase interest rates to reflect the risk that we’ve become.
This fuels another concern: inflation. To get deficits under control, the federal government could cut spending or increase taxes (or both). Neither of these policies are popular, hence the temptation to resort to printing money (or “monetizing the debt”) to pay its bills.
However, there is no free lunch. The resulting inflation reduces the value of each one of your dollars and also introduces high levels of uncertainty. Obviously, the Federal Reserve is unwilling to take such a dramatic step today. However, investors know that other central banks have done this in the past and it could happen again, so, in exchange for extending more loans to the federal government (which has become a riskier client), lenders could soon be asking for a higher interest rate — an inflation premium.
The only way to address the increasing costs of our debt is to address the driving forces behind it — legislated explosions in Social Security, Medicare, and Medicaid spending.