Tuesday, June 05, 2012

The Fallacy of Cheap Interest

I am not an economist, and I don’t have any great degree of financial education either, but the argument that we should keep borrowing simply because interest rates are low seems nonsensical to me on several fronts. To use that as one of several arguments might make sense, but it is often used as pretty much the sole argument.

To set the record straight, I do think the government should be doing some sort of “New Deal” spending right now to create jobs. It would be better than spending money for unemployment benefits, which doesn’t provide us with any direct return on our investment. If we have to borrow some money to do that I think that is a case of necessary borrowing. I do not subscribe to the theory that doing this will “kick start the economy,” but it will help people who don’t have jobs.

But the argument that we can borrow endlessly merely because current interest rates are low just seems too much like a “free lunch” proposition.

For one thing it assumes that the borrowed money does not ever have to be paid back. Paul Krugman and Dean Baker, of course, argue precisely that; governments never repay debt. Krugman has a formula based on the post-WW2 era where the debt incurred in fighting that war was subsumed in a growing economy until it vanished without us ever paying it back. I’m pretty sure the “never paid it back” part is bogus, because the government sold some $190 billion in war bonds and only about $9 billion are currently outstanding, so I believe at least $185 billion was paid back. I’ve already discussed economic growth when you have no global competition because you just bombed all of it into rubble, so I won’t bore you with that again.

Even low interest is not “no interest.” This year, with our current debt and the current “historically low interest rates,” we will pay $414 billion in interest. That is the third largest item in the nation’s budget. If we borrow more money it will go up and, if Krugman and Baker are correct and we do not repay any of the debt, we will continue to pay that interest forever. And we get nothing for that expenditure; that is payment for past behavior.

That assumes that the interest rate remains low. All of this debt is “term debt” that must be refinanced when it becomes due. What happens if the interest rate has increased when that refinance date arrives? That should not be “if the rate is higher,” because the rate will be higher. We will be paying more interest, a lot more interest, even without additional borrowing.

Economists try to calm us by saying that our national debt is still slightly less than our GDP and that it can even be slightly higher than our GDP and we will be okay. Sounds good, but what does it really mean?

What jumps to mind is your comparison of debt to annual income, doesn’t it? If you own a house your debt is probably larger than your annual income, maybe twice or more in fact, so that ratio of national debt to GDP actually sounds pretty good. But…

National income and GDP are vastly different things. Exclusive of Social Security and Medicare, which are not federal income and cannot be used to pay down debt, federal income at this point is about $1.9 trillion per year. That means that our debt of $15.7 trillion is well over eight times our national income. No financier would regard that as a healthy balance sheet, and no sane banker would lend money to someone who had existing debt exceeding eight times annual income.

Granted, a nation is not a household or a business, but still…

1 comment:

bruce said...

There are WWII war bonds still outstanding? wow... PK & DB may not think debt gets paid back, but if all you pay is interest, the principal never gets touched. So they are right in a way... And yes, no one in their right accounting mind thinks this is a good thing.

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