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Thursday, February 17, 2022

Why Debt Matters

 Desmond Lachman at Inside Sources:

The major problem with a high public debt level is that it saddles the government with large future interest payment obligations. That leaves little room for other public expenditures and makes it difficult for the government to bring the budget deficit under control. Failing to rein in the deficit, in turn, risks keeping the public debt on an ever-increasing path. In that context, it has to be of deep concern that the non-partisan Congressional Budget Office is forecasting that on present trends the country’s public debt to GDP ratio will approximately double from around 100 percent at present to 200 percent by 2050.

A high public debt level highly compromises the Federal Reserve’s ability to keep inflation under control. In particular, it makes it difficult for the Fed to raise interest rates for fear of adding to the government’s interest payment burden. Such a consideration would seem to have particular pertinence today with inflation running at its fastest pace in the past forty years and with the Fed needing to raise interest rates substantially from its present zero bound if it hopes to get the inflation genie back into the bottle.

Especially at a time of high inflation, a high public debt level makes the country economically vulnerable. That is because we have become the world’s largest debtor nation. For many years now, we have relied on the kindness of strangers in general and on the Chinese and Japanese in particular to finance our budget excesses.

If foreigners begin to perceive that we are in the process of inflating away our debt, they will be reluctant to hold that debt and will demand higher interest rates in order to compensate them for inflation risk. That in turn could cause the dollar to swoon, which would only add to inflationary pressures and fuel further concerns about our wanting to inflate away our debt.