Tax Analysts Blog

A Sure Bet in Uncertain Times

Posted on May 29, 2009

High anxiety kept bond traders on their toes on Wednesday and Thursday as yields on government bonds continued their climb. The Financial Times reports that when Treasury Secretary Geithner goes to China next week he will reassure that nation's leaders that the U.S. is committed to long-term fiscal discipline. But all Geithner can offers are words, not actions. As the Washington Post points out: "The administration's plan has been to turn attention to the longer-term budget mess next year."

Paul Krugman ("The Big Inflation Scare") tells us not to worry that rising debt will stoke inflation. He says that "current inflation fear-mongering is partly political" coming from the right. And the Financial Times ("U.S. Not in Bondage") tells us not to panic about rising interest rates, explaining that interest rates are returning to normal post-panic, end-of-recession levels.

But none of the aforementioned sources are suggesting the U.S. is in the clear. The Post: "A scheme to get a handle on the debt cannot be delayed." Krugman: "We have a long-term budget problem, and we need to begin to lay out a long-term solution." And the Financial Times: "Desirable normalization [of interest rate levels] could yet become a panic over the massive prospective bond issuance . . . The administration and Congress need to agree to a credible plan for elimination of the huge structural budget deficits."

So what exactly is the problem with deficits? As Krugman argues, fear of inflation is probably overblown. And fear of some sort of shock to the U.S. government's ability to borrow (a major credit downgrade, a Chinese refusal to purchase any more Treasury securities) is simply not in the cards.

But here is one sure bet no matter what happens with inflation and interest rates: the government's seemingly insatiable appetite for debt will stifle America's long-term economic growth. To service the debt we must continuously pay huge amounts of interest to foreign lenders. On top of that, when we issue government debt, we crowd out domestic capital formation that would be the foundation of future prosperity. This is the price we pay for the bailout and for the stimulus packages.

Or did you think you could have all that for free?

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