Temporary vs. ultimate default
President Biden and House Speaker McCarthy met yesterday on the debt ceiling crisis, as cash in the Treasury General Account fell to an alarming low of $87 billion, according to the most recent Daily Treasury Statement. Yet, the debt ceiling crisis is but a symptom of a much more consequential debt crisis in the U.S.
It is not too much of an exaggeration to say that Biden’s massive spending imperils the nation, risking an eventual fatal default, not simply a temporary immediately-curable default. The debt ceiling crisis has served a valuable function in forcing the nation to confront its unsustainable spending habit and its mountain of accumulated debt.
Very much sooner than expected, we will arrive at the ‘X Date,’ the day on which the Treasury runs out of money to pay Uncle Sam’s bills. Treasury Secretary Yellen badly misjudged the ‘X Date,’ only realizing her error a couple of weeks ago.
Ill-advised by Yellen or acting on his own accord, President Biden refused, for three months, to negotiate with House Speaker McCarthy… until this week. For the good of the nation, McCarthy should not yield on House Republicans’ demands for spending cuts.
While deficits are not new under Biden, they are of distinctly un-survivable magnitude. Moreover, Biden is particularly blameworthy, since it is plainly obvious that his spending is the straw that is breaking the camel’s back through record inflation and widening deficits. Previous profligacy may have been as reprehensible, but it did not break the nation.
Last Wednesday’s Monthly Treasury Statement showed a seven-month deficit of $925 billion, more than double the seven-month deficit of $393 billion in fiscal 2022. The full-year deficit in fiscal 2023 is certain to surpass $2 trillion.
Deficits require additional borrowing in equal amount. A $2 trillion deficit necessitates $2 trillion of new debt, or yet another $1.5 trillion to be raised by September 30 on top of the half-trillion that had already been borrowed this fiscal year by the time the national debt hit the current $31.4 trillion ceiling in January.
Stunning enough numbers, but what really makes the debt crisis manifest and urgent is skyrocketing interest on the debt. Net interest (gross interest less interest on the $6 trillion of Treasuries held in government trust accounts) increased a whopping $107 billion, or 40%, in the first seven months of fiscal 2023.
Inevitably, it will continue to increase, as outstanding Treasuries with lower interest rates mature and are replaced by new ones with the much higher interest rates produced by the Federal Reserve’s interest rate hikes over the last year. Another $107 billion increase over the next five months would increase full-year net interest expense to about $690 billion compared to $475 billion last year.
Interest of $690 billion on the $28 trillion of net national debt implies an average embedded interest rate on total outstanding Treasuries of about 2.5% ($690 billion divided by $2,800 billion) at the end of fiscal 2023. That is far below interest rates today (about 5.25% on short-term Treasury bills and more than 3.5% on long-term Treasury bonds).
Soon, interest expense will exceed every item in the budget except Social Security.
Treasury interest rates drive all interest rates, so a massive increase in interest cost is being experienced across the broad economy, making recession quite possible, if not probable.
While, in a recession, interest rates would come down, federal interest expense would still rise. Tax receipts would decline, forcing Uncle Sam to borrow much more to replace the lost tax revenue. During the Great Recession, tax receipts fell 25% from 2008 to 2009. So, even at lower interest rates, the federal government’s interest expense would remain high – and debt would surge to new heights.
The upshot is that, without cutting spending, the likely scenarios lead to continued unaffordable levels of interest expense and an ever higher mountain of debt.
Yet some people in Washington still resist. They claim that not raising the debt ceiling amounts somehow to reneging on financial commitments already made.
In truth, a debt ceiling increase is needed to fund past commitments, if, and only if, those past commitments were not funded when made. That is the problem in Washington: ever more unfunded spending. We need to fund commitments when made.
Yesterday, perhaps frightened by fast disappearing federal cash, Biden abandoned his months-long demand for a “clean” debt ceiling raise. Maybe, he understands that using new debt to fund past deficit spending only encourages even more of the same. Unquestionably, it is unfunded spending that has led to our current perilous position and that, sooner than later, will lead to fundamental default, not temporary immediately-curable default. It is imperative to cut spending while raising the debt ceiling.