Last Monday, the Trump Administration reached a deal with Speaker Nancy Pelosi and congressional leaders to eliminate the sequester and spend more money, all but guaranteeing trillion dollar deficits each of the next two years. This red ink has caused consternation among budget hawks and “fiscal conservatives.” Back in the early 2010’s, I was one such individual, fretting about our nation’s financial health.
Let me be clear, I was wrong during the Obama years to worry about the national debt and budget deficits. Data increasingly shows deficits and rising debt are sustainable at much higher levels in the US, a country which issues debt in its own currency, with fewer negative side-effects than feared. It’s even unclear the national debt matters at all. In fact, if there is a problem in Washington, it is that the deficit is too small. I urge fellow conservatives to join me and stop worrying about the debt.
Conservatives say we believe in the wisdom of market forces. If markets were worried about the US’s financial health, they should demand higher levels of interest to compensate for this risk. Well, US interest rates are exceptionally low, implying tremendous calm about our financial health. Even amid worries about entitlements in the future, our cost to borrow for 30 years is only about 2.6%. A decade ago, the market demanded 4.5%; in the late 1990s when there was a surplus, we borrowed at 6%. Frankly, the Treasury should exclusively issue long-dated bonds to lock in these rock-bottom rates for a generation. Why the Trump Administration has failed to do this is beyond my comprehension and a dereliction of duty.
We should use today’s cheap financing to increase the deficit and enact pro-growth fiscal policies. A nation with a debt/GDP ratio of 100% that borrows at 3% for 30 years and can grow nominal GDP at 4% would see its debt/GDP fall to 75% when the debt comes due or 56% at 5% nominal growth. If you believe America can grow in the future as it has in the past (5% nominal [3% real and 2% inflation]), you should support large deficits funded by locked-in, low rates as GDP growth will diminish the debt burden.
Let’s also dismiss this notion of having to “pay off the debt.” Individuals have to get their debt (on credit cards, mortgages, student loans etc) to $0 eventually because we hope some day to stop earning an income and retire. The lack of income requires a lack of debt service payments. As a whole, the US economy will never “retire.” We will generate GDP and tax revenue forever (or at least, that should be the plan), and as such, we will simply refinance the debt, issuing new bonds to repay old ones. We don’t ever need to bring the national debt to zero. Again, given how low rates are today, we should minimize refinancing risk by locking in these rates for as many years as possible.
Ultimately due to technology, globalization, and central bank policy, there is an excess of global capital. Austria issued a 100-year bond at around 1.2% while investors are literally paying for the privilege of lending to Germany. Yes, they give the German government $100 and accept less than $100 back in 10 years’ time. There is over $12 trillion of debt globally that guarantees a negative return to maturity via negative yields. In this world, thanks to the strength of our domestic economy, America has globally high interest rates. We shouldn’t be afraid to satiate yield-starved global investors by offering them more and more US treasury bonds at yields that are still cheap relative to our underlying economic fundamentals. Borrowing when money is cheap is a winning strategy; let’s take advantage of the global savings glut.
In the past, conservatives have worried deficits would undermine the dollar. Well, the trade-weighted dollar is within 2% of its all-time high. Higher domestic yields have foreign investors flooding into US assets, again unafraid by US debt dynamics. Frankly, the dollar is arguably too high at these lofty heights, weakening the global competitiveness of US manufacturers and exporters. To offset this strength, we could reasonably fund part of this deficit by printing dollars to monetize a portion of the deficit, rather than fund it with new bonds.
Why are markets unworried about rising US debt levels? Well, countries keep running higher debt totals with no problem. Japan has moved well past 100% debt to GDP, a level once thought scary, and is now well past 200% with no default worries. This is because government debt (in a country that issues debt in its own currency) seems to be more of an accounting exercise than of economic importance.
If tomorrow, we cut taxes by $1 trillion, the public sector would incur $1 trillion of incremental debt, but that’s negated by the $1 trillion of new private sector savings in the form of foregone taxes. Indeed, we are seeing this play out with Trump’s tax cuts increasing the budget deficit (the public sector) and the personal savings rate (the public sector) rising past 8%. In America’s national accounts combing and netting public and private sector balances, no net liabilities (as a government bond bought by a US household is a public sector liability and private sector asset) are created, and it is for this reason that higher debt levels have been sustained without problem. With our reserve currency and high private sector savings (households retain a net worth of $108 trillion, providing ample capital for government debt and to fund private sector investments), our government debt functions as little more than an accounting exercise given offsetting private sector holdings, and is not something to worry about. As long as the US debt remains largely held by US households, the central bank, and captive foreign investors, there probably is no limit to the stock of debt we can carry.
Now while the debt doesn’t matter, deficits do. What is the optimal deficit level? Really, it depends. With the Federal Reserve, we do not demand they target a level of interest rates, as no number is naturally better than another, rather we ask they target preferable conditions, namely “full employment and stable prices.” Similarly, the deficit level itself should not be the target, rather strong economic conditions should be the goal, with deficit spending to accommodate this target. Overly loose fiscal policy can cause excess inflation whereas overly constrictive policy excess unemployment.
Frankly, the Federal Reserve has failed to deliver its objectives with a structural preference for excess unemployment rather than excess inflation for the past two decades. For the past 20 years, core inflation has been 1.7% vs the 2% target, for a cumulative “miss” of 6%.
This bias has been a driver of rising inequality and stagnant median incomes because it is when the labor market is tight and economy is running hot that wage growth is the best. However by tightening policy as inflation nears 2%, the Fed cuts short periods of time when laborers get bigger raises, resulting in wage growth that lags economic growth and a hollowing out of the middle class. An economy that is run somewhat cool is one where the top 1% reap an inordinate share of the gains because growth is strong enough to sustain high corporate profits while a not-too-hot labor market allows employers not to raise wages much and cede much of those profits to workers. Given this long-running miss in the inflation target, combined with the fact inflation hasn’t been a problem in decades (it hasn’t been 3% in 26 years), now is an opportune time to use fiscal policy to achieve what monetary policy refuses to: a hot, tight economy, which can deliver disproportionate gains to working people, rebuild the middle class, and reduce inequality. In coming pieces, I hope to discuss fiscal ideas conservatives should support to enhance economic growth, rebuild the middle class, increase personal responsibility, and strengthen families.
Importantly as a final note, a preference for deficit financing should not be confused with supporting wasteful spending or ever-growing government. Wasteful spending is never justified as it is always preferable to spend on projects that generate the best returns for citizens. Similarly, bigger government isn’t needed to increase the deficit; cutting taxes significantly while holding spending flat will widen the deficit. Ultimately, I would prefer increasing the deficit primarily via middle and working class tax cuts combined with some incremental infrastructure investment. And because while debt doesn’t matter, but deficits can impact inflation by heating up an economy, running a structurally higher deficit is not necessarily sound. When the economy is too hot, the deficit must contract to avoid excess inflation. But right now, that is the least of our problems.
Given this recognition that market forces welcome more US debt, that government debt is more of an accounting exercise than economic concern, and that the economic environment of low inflation supports a higher deficit to boost wage gains with minimal externalities, now is an opportune time for the Administration to boost the US deficit by 1-2% of GDP ($200-400 billion) via a combination of debt issuance and dollar creation. This policy would further boost the Trump economic boom and deliver more gains for middle-income households. It’s time conservatives accept that our deficit worries in the Obama years were just plain wrong and that we unapologetically run up more red ink.