With U.S. government debt at $40 trillion and rising—the total marketable debt is $31.4 trillion and non-marketable is $8.3 trillion—the notion that we can grow our way out of the debt should be not so gently retired.
To understand why, consider the idea of r-g—or the gap between the interest rate that the U.S. pays on its debt (the r) and the economy’s growth rate (the g). It sets the baseline of whether the current level of debt is sustainable.
Watch Joe Brusuelas talk about the need for fiscal consolidation in his interview on CNN.
In short, it is the key driver of whether the debt to gross domestic product ratio is at risk of spiraling into a crisis or stabilizes on its own regardless of whether government spending is in balance or the primary budget (the budget excluding interest paid on past debt) is in balance.
If r<g, the economy grows faster than the debt increases, which results in a declining debt-to-GDP ratio so long as the primary budget deficit remains in balance.
This is what the economist Olivier Blanchard referred to as the low-rate free lunch.
If r>g, then debt increases faster than growth in the economy, which results in an increase in the debt-to-GDP ratio even if the primary budget remains in balance, which as one might suspect is a bad thing that can lead to a fiscal, financial and/or banking crisis.
Under such conditions the primary budget needs to remain in balance just to keep the fiscal situation from deteriorating.
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With the regime change in interest rates and inflation that has characterized the post-pandemic era, the free lunch of the past 20 years has come to an end.
Even an artificial intelligence-driven boom over the next few years will not be sufficient to avoid hard budget choices in Washington.
Fortunately, we are not on the precipice of a debt crisis.
Under current economic conditions, the only way to drive rates lower outside of a policy of quantitative easing by the central bank or yield curve control—which would bring about the Japanification of the American economy—is to act to put the primary budget in balance.
The U.S. should act quickly to begin a sober and clear-eyed conversation around what fiscal consolidation looks like, what it requires and how long it will take to put the primary budget deficit in balance.
That will require a look at both mandatory and discretionary spending as well as levels and sources of tax revenues.
Global investors because of the fiscal profligacy of the past generation are now pivoting in their preferences for holding U.S. issued paper.
Potential purchasers of American-issued paper are now paying close attention to the fiscal condition and outlook of Washington in the context of increasing competition for scarce capital amid rising inflation.
Rate-sensitive investors such as foreign governments and central bankers are reducing their exposure to the risk associated with holding American debt.
While rate-sensitive investors are still willing to purchase that debt, they are now charging a rising risk premium to do so.
Because the U.S. dollar remains the global reserve currency, this implies that the U.S. has time to get its fiscal house in order.
However, just because there is not an American fiscal debt crisis on deck or even over the horizon, that does not mean that Washington should tempt fate.
Inflation and interest rates are rising.
And rates could rise further, absent a debt crisis, should a credible mix of rising revenues, slower growth in government spending and/or outright cuts not be implemented soon.
