The CBO isn’t looking for a financial crisis until 2053. That looks optimistic, but setting a precise alternate date is unwise.
Michele Wucker has defined a “gray rhino” as:
a highly probable, high impact yet neglected threat: kin to both the elephant in the room and the improbable and unforeseeable black swan. Gray rhinos are not random surprises, but occur after a series of warnings and visible evidence. The bursting of the housing bubble in 2008, the devastating aftermath of Hurricane Katrina and other natural disasters, the new digital technologies that upended the media world, the fall of the Soviet Union . . . all were evident well in advance.
I’ve borrowed the term to describe the situation in the office-property market, but it works very well to describe the position with regard to U.S. government debt.
It’s worth taking the time to look at Mark Warshawsky’s grim article on this topic in Capital Matters yesterday. He looks at the bleak picture painted by the CBO and then demonstrates how this is, if anything, optimistic.
Among other factors, he considers the impact of rising interest rates:
The other component of the deficit is interest spending — the product of the effective rate of interest and debt outstanding. Instead of CBO’s assumption that interest rates will decline in the future, I assume that the base level of interest rates is today’s rate: 4.25 percent on ten-year Treasury bonds. Short-term rates are now higher — around 5.5 percent — and it is possible that the Federal Reserve will lower those rates somewhat if inflation comes down.
But there is no reason to expect that long-term rates will decline. To the contrary, as growing federal debt crowds out private capital, interest rates can be expected to increase slowly (as I and others have shown in empirical research) and I include this effect in the projection model. The effective interest rate on federal debt by 2039 rises to 6.0 percent.
Combining these calculations gives us a result showing that the deficit will increase to 8.8 percent of GDP in 2029, 11.1 percent in 2034, and 14.4 percent in 2039. Debt outstanding will increase to 115 percent of GDP in 2029, 138 percent in 2034, and 168 percent in 2039, a level near that which International Monetary Fund economists estimate will result in a financial crisis for the United States and which the CBO doesn’t expect us to reach until 2053. Other research shows that significant declines in the standard of living occur with these levels of indebtedness as the economy is starved of capital.
In a series of cheerless tweets, the indefatigable Brian Riedl gave some of his thoughts on the CBO’s numbers, for example, here:
CBO assumes the interest rate on the debt gradually rises to 4% over three decades. Each 1% above that rate adds $35-to-$45 trillion in interest costs over three decades, or roughly the cost adding another Defense Dept. That’s just for each percentage point rates rise.
And here:
The rise in the neutral, equilibrium interest rate over the holiday-from-history levels of 2007-21 risks a potentially catastrophic impact on soaring federal debt. Over the long-run, 4% rates are very bad, and at 5% or 6%, interest eventually costs 60%-100% of annual tax revenue.
Riedl is right to refer to interest rates between 2007-21 as a “holiday-from-history,” although they were undoubtedly historic, too. On some calculations, they reached 4,000-year lows. This age of ultra-low interest rates began in response to the financial crisis, but persisted and persisted (in part due to intervention by the Fed), and then came Covid. . . .
One of the mysteries (to me) of that era is the failure of the government to lock in these very low rates on its debt. After all, this was a time in which Argentina (Argentina!) was able to issue a 100-year bond (shockingly, it didn’t work out well for investors).
Ultra-low rates were always likely to revert to more normal levels. And when they did, the legacy of over a decade of mispriced money was always likely to be ugly: It’s one reason for the current troubles in the office property market). But what does “normal” mean?
Riedl was also reacting to a comment on Goldman Sachs’s view that the market was signaling that the nominal neutral rate of interest is around 4 percent, not a number, as noted above, to bring much joy to the Treasury and a number, as also noted above, that may well be increasing.
In this connection, these comments by economist Kenneth Rogoff from a little over a year ago (I wrote about them here) are worth recalling:
Other factors that are pushing up long-term real rates include the massive costs of the green transition and the coming increase in defence expenditure around the world.
Massive costs of the green transition, eh?
To go back to Warshawski:
Projections are not forecasts but rather policy exercises to show the administration, Congress, and the public what will occur on the current policy path, according to the best economic science. The current fiscal direction is not sustainable — even without emergencies such as wars, pandemics, and recessions — and proposals to further increase government spending must be regarded as folly.
Oh well.
The CBO isn’t looking for a financial crisis until 2053. That looks optimistic, but setting a precise alternate date is unwise. What seems certain is that if we don’t change course, there will, sooner or later, be a massive market panic over the debt, with potential buyers running for the hills. What will set off that panic is anyone’s guess (markets are like that), but when it happens. . . .