By Daniel Lacalle, The Mises Institute | June 19, 2023
Since 1960, Congress has raised the debt ceiling 78 times, according to Bloomberg. The process of increasing the debt limit has become so regular that markets barely worry about it. Furthermore, as the 2011 debt ceiling crisis showed, the impact on asset prices happened mostly in emerging economies. In 2011, Turkish and Indian debt were the most negatively impacted, while Treasuries rose.
Politicians believe that raising the debt ceiling is a social policy and that debt does not matter. Until it does. United States debt to GDP is now 123.4% and the risk of losing confidence on U.S. treasuries as the lowest risk asset is exceedingly high.
The problem in the United States budget is evident in mandatory and discretionary spending. Focusing all the attention on discretionary spending does not solve the deficit and debt problem. Trying to convince American citizens that the entire debt problem can be solved with higher taxes is also lying to them.
Mandatory spending is around 63% of the budget, discretionary spending almost 30% and, despite low borrowing costs, net interests already consume 8% of the budget.
The United States budget is unsustainable however you want to look at it.
Projections for fiscal year 2023 show outlays of $5.9 trillion. Outlays rose after the Covid-19 pandemic. However, instead of bringing them back to pre-pandemic level, expenses have been consolidated and annualized. The U.S. budget had already an expense problem earlier, as outlays rose above economic growth.
The same projections, courtesy of the Center on Budget and Policy Priorities, estimate a $1 trillion deficit even after considering a record $4.0 trillion in revenues.
There is no way in which the United States can cut the budget deficit to zero with higher taxes and revenues measures. It is impossible for the U.S. economy to generate a consolidated annual increase in tax receipts of $1 trillion over a cyclical high of $4.9 trillion. And this is only to bring the deficit to zero, it does not even start to address the much-needed net debt reduction.
Deficits are always a spending problem, because receipts are, by nature, cyclical and volatile, while spending becomes untouchable and increased every year.
The Neo-Keynesians will say that deficits do not matter, and debt is an asset for the rest of the world. If that were the case, why the obsession with massive tax hikes? Obviously, the idea that deficits and debt do not matter because they are constantly refinanced makes no sense. Deficits and debt matter because the confidence in the solvency of the state and its currency is predicated on its ability to manage debt to a level that does not scare off domestic and international investors. Debt is only an asset to others if the solvency of the issuing state is not under question.
The biggest problem is that the United states’ solvency and confidence are under question globally. Central banks are reducing exposure to U.S. Treasuries as a reserve asset precisely because of diminishing confidence in the public accounts as well as rising concerns about the safety and strength of government bonds as a safe haven. In 2022, many central banks saw their reserves collapse due to the decline in value of Treasuries.
The entire Neo-Keynesian fallacy is based on the idea that the state can always absorb more wealth from the private sector at no cost. However, that cost is already evident. Inflation is here, and it is a direct consequence of years of monetization of government debt. Furthermore, the dangerous cocktail includes high inflation, rising taxes and increasing debt. There is no improvement in the public accounts even with record receipts. Inflation is not reducing the overall debt level because deficit spending rises alongside consumer prices, even higher.
The world is questioning the United States’ public finances and that is why Congress needs to act and reign on spending. If things continue this way, discretionary spending will reach $2.5 trillion in a decade, and deficit spending will still be half a trillion US dollars at the end of the same period even if the economy grows without recessions or crisis years, a true impossibility, and employment does not suffer.
The United States budget is completely unsustainable, and the problem is elevated and wasteful spending. If Congress does not work to curb spending, the global confidence on the U.S. debt is likely to slump, and higher monetization will only make things worse because it will destroy confidence in the entire monetary system starting with the currency.
Maintaining these enormous fiscal imbalances will not be solved by raising taxes. It is impossible to add $1 trillion revenues every year all the time. Furthermore, higher receipts would also lead to governments feeling comfortable and spending even more.
The gigantic fiscal imbalances of the United States are putting the U.S. dollar and the safety of the national debt at risk. There is nothing social about destroying a currency’s reserve status and a bond’s attractiveness for investors.
If politicians really care about the U.S. citizens and their welfare, they should defend the currency and the solvency of the public accounts. Any other measure will only make the debt ticking bomb explode earlier in the face of our sons and daughters.
2022 was a warning sign that debunked the myth of eternal monetization of debt with low inflation. It is time to be serious.
Higher debt means more taxes, weaker growth, and weaker real wages in the future. High deficit spending is not a tool for growth, but a tool for cronyism and a burden on the future.
Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and Life in the Financial Markets (2014). He is a professor of global economy at IE Business School in Madrid.
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