Deficit "Hawks" Are Shouting at Market Signals That Mock Them

U.S. federal debt added up to $908 billion in 1980, but today, nearly 40 years later, the number comes in around $22 trillion. And then as the perpetually alarmed regularly remind us (in The Hill yesterday, economist Bert Ely warned readers in yet another column that "our day of fiscal reckoning nears"....) the previous number doesn’t come close to tallying the gargantuan sums the federal government owes when unfunded future liabilities are factored in.

That the amount owed by U.S. taxpayers has soared in modern times would, in a static world, correlate with a huge increase in borrowing costs for the U.S. Treasury. Wouldn’t it?

Except that the world isn't static, and borrowing costs haven’t risen. While the yield on 10-Year U.S. Treasuries was 10.8 percent in 1980, as of today the yield has declined to 2.668%. Yes, you read that right, amid soaring federal debt the cost of government borrowing has plummeted.

The deepest markets in the world are sending a fairly explicit signal that Treasury will have little problem paying back what it owes. Markets are constantly pricing the known, and it’s apparent that what has some thinking America is the next Greece doesn’t scare those with actual skin in the game. Stated simply, the U.S. Treasury doesn’t have a borrowing problem.

What it paradoxically has is a problem of too much revenue. Evidence supporting the previous claim is all the borrowing that Treasury can conduct now and in the future, and without investors charging a major premium for the privilege.

Lest readers forget, a Treasury bill, note or bond represents a stream of future payments made in dollars by the U.S. Treasury. That yields are so low speaks to market confidence that there won’t be a substantial devaluation of the dollar in the foreseeable future, but perhaps more importantly it’s a sign that investors envision Treasury collecting abundant tax revenues for a very long time.

The presumption of soaring future tax collection plainly makes the risk of lending to the federal government somewhat inconsequential to investors whose job it is to calculate risk. So while the total amount of money owed by the federal government may appear daunting, perhaps too easily forgotten is that the U.S. Treasury is backed by the most productive people on earth. The American people and the economy they represent make Treasury debt a good bet. If investors expected tax revenues to plummet, Treasury’s borrowing costs would presumably rise to reflect greater risk of non-payment, or devaluation of those payments.

Importantly, none of what’s been written so far should be construed as an endorsement of government borrowing. It’s just a comment that the borrowing is an effect of how much tax revenue Treasury collects now, and how much investors expect it to collect in the future. The U.S. Treasury can borrow in size amounts precisely because it collects in size.

It all raises a basic question of why government debt has so many so up in arms, when it plainly doesn’t worry investors. Implicit in the fears expressed by the deficit obsessed is that they know something that the deepest markets in the world do not. The latter is unlikely. Unless markets are thoroughly stupid, and have been dense for decades, the fears of deficit worriers appear misplaced. Their time would be better spent focusing on the real problem: the tax that is government spending.

To see why, readers need only consider two rather opposite budget scenarios. In the first, the annual federal budget is balanced to the tune of $4 trillion. In the other, the feds spend $2 trillion annually, of which half of the funds are borrowed. Which scenario is more economically stimulative? The answer to this question should be a simple one. Take the $2 trillion budget with $1 trillion borrowed in a heartbeat, and do so because it represents $2 trillion fewer dollars spent each year by the federal government.

It can’t be forgotten that federal spending is the real tax. When the federal government spends, that means Nancy Pelosi, Kevin McCarthy, Chuck Schumer and Mitch McConnell are allocating precious resources in non-market fashion, and to the detriment of the private sector. Assuming $2 trillion in reduced federal spending, that means future Microsofts and Amazons have the potential to attain funding versus the undeniable waste that occurs when politicians usurp the role of private investor.

Looking into the future, it’s no insight to say that so long as taxpayers provide politicians with tax revenues, politicians will spend them. Better yet, so long as taxpayers produce ever-increasing revenues for the political class, substantial borrowing by Treasury will logically be very simple for reasons previously explained.

In that case, there’s a simple answer that would please those who favor small government, and in the process please the deficit hawks who’ve mistaken balanced budgets for small government: reduce tax rates to a level that brings federal revenues down. If so, politicians will have less to spend, and they’ll also have reduced capacity to borrow.

The deficit hawks are right that we have a revenue problem. What they gloss over is that the problem is one of tax revenues that are way too high.