Inflation and deficits do not dampen the attractiveness of US bonds
Mr. Bernstein noted that while debt financing has its place, the White House also believes it has firm boundaries within its agenda. “The outcome of all this will be a mix of incremental revenues and high-return investments in essential public goods, funded by borrowing.”
Looking ahead and into the past
What would have to happen for these extremely low borrowing costs to rise significantly? There could be a crisis of confidence in Fed policy, a geopolitical crisis, or steep hikes in Fed interest rates to kill inflation. In an easier-to-imagine situation, some believe that if inflation stays near current levels in the second half of the year until yields are more aligned with rising prices, bondbuyers could lose patience and scale back purchases.
The resulting higher interest payments on debt would force budget cuts, said Marc Goldwein, senior policy director with the Federal Budget Committee. Mr. Goldwein’s organization, which is pushing for lower deficits, estimated that even with last year’s low interest rates, the federal government would spend over $300 billion on interest payments – more than their individual spending on food stamps, housing, disability insurance, science, education or technology.
Last month, Brian Riedl, senior fellow at the right-wing Manhattan Institute, published a paper entitled “How Higher Interest Rates Could Push Washington Into a Sovereign Debt Crisis.” It concludes that “debt is expected to rise to unsustainable levels even before new proposals come into force.”
The compensating global and demographic trends that have pushed rates lower, writes Mr. Reidl, are an “incidental and possibly temporary subsidy to heavily borrowing federal lawmakers.” Assuming these trends continue, it would be like becoming a complacent football team that “managed to improve their overall win-loss record over several seasons — despite a rapidly deteriorating defense — because their Offensive has continued to improve to barely outperform his opponents.”
But at least one historical trend suggests that interest rates will remain tame: a six-century decline in real interest rates worldwide.
A 2020 paper published by the Bank of England and authored by Paul Schmelzing, a postdoctoral fellow at the Yale School of Management, found that as political and financial systems become more global, innovative and mature, the safest borrowers – strong governments – default. have steadily declined. According to his paper, one consequence of this could be that “regardless of certain monetary and fiscal responses, real interest rates could soon turn permanently into negative territory,” which yields less than the inflation rate.