The Trump administration is testing just how much government debt is too much.
Washington is set to return to annual budget deficits of $1 trillion or more. The only other time this happened was from 2009 to 2012, as a bad recession hit, tax revenue plunged and Congress passed aggressive stimulus programs to mitigate the damage. Annual deficits fell after that, hitting $438 billion in 2015. In the last complete fiscal year, the deficit was $666 billion.
Deficits are going much higher—and this time, there’s no recession. In fact, the economy’s in good shape. Still, the tax cuts signed by President Trump at the end of 2017, along with a big new boost in military and domestic spending, will send annual deficits soaring to close to $1 trillion in 2018, and probably beyond $1 trillion in 2019 and 2020.
Will that cause a problem? Nobody knows for sure, but there’s some unknown point at which excessive government borrowing will hurt the broader economy and possibly even cause a recession. “Too much government debt crowds out private lending,” says Joe Brusuelas, chief economist at investing firm RSM. “The private sector has to pay a lot more, it slows the pace of investment and hiring, and you get slower growth. The governing party just added $3 trillion to what the kids are going to have to pay back, and the kids have no idea what’s happening to them.”
Economists used to think the threshold for government debt was lower than it appears to be. As the federal debt approached, then exceeded, 100% of the nation’s GDP, some investors feared borrowers would begin to doubt Uncle Sam’s ability to pay back all that money, and demand higher interest rates. But that hasn’t happened, and that’s one big reason Congress seems willing to pile on the debt to fund just about every pet project in Washington.
The recently approved spending bill eliminates budget caps imposed in 2011, and it will add about $320 billion to the national debt during the next decade. That comes after a tax-cut bill likely to add another $1.5 trillion to the debt during the same time. And most analysts expect “temporary” tax cuts enacted last year to become permanent, pushing the total tally of new debt to around $3 trillion over a decade. The national debt is now 19% larger than the entire U.S. economy, a gap that will continue to grow.
On a per capital basis, the national debt amounted to $19,948 per person in 2000, and $43,733 in 2010. By 2019, it will be around $68,000 per person:
What’s the problem with that? Sooner or later, all that government debt could essentially flood the credit markets, pushing the price of government securities down and the yields, or interest rates, up. Investors will simply demand more in return for loaning the government money. Rising rates will make it harder and costlier for private-sector businesses to borrow and invest. They’ll hire less, at the same time borrowing costs are rising for consumers. That’s one way for an economic expansion to slow down or end, and a recession to start.
As interest rates rise, the government itself will have to pay more to borrow. Net interest costs only account for about 7% of all federal outlays right now, which is low, historically, even though the national debt is at a record high. That’s because interest rates have been so low. But interest payments will shoot up as interest rates rise, which will leave less federal money for social programs, defense, roads, bridges and everything else. The government can raise revenue quickly in an emergency, by raising taxes. But that in itself can cause a recession if it happens too abruptly.
The recent stock-market selloff probably doesn’t reflect this concern, at least not yet. Stock prices have been falling because inflation seems to be heading higher than investors expected up till now. That’s based on recent data, not on projections involving future levels of federal debt. Congress didn’t even pass the latest spending bill until the recent selloff was underway.
But concerns are mounting. Hedge-fund billionaire Paul Tudor Jones, for instance, wrote in a recent letter to investors that he’d rather hold “hot burning coal” than Treasury bonds, because of the “detrimental effects excessive public sector borrowing has on the economy.” In his letter, he referred to the 1980s, another period when tax cuts and spending led to a surge in government borrowing and federal deficits.
President Ronald Reagan is remembered for the big tax cut he signed in 1981 and for a large boost in military spending. Yet the national debt rose by 188% during his time in office, and Reagan raised taxes three times to deal with concerns about excessive government debt. The national debt rose another 52% during the next four years, under George H. W. Bush, and a recession contributed to his defeat in 1992. Bill Clinton and his first Treasury Secretary, Robert Rubin, put an end to the explosion in government debt, at least until the 21st century arrived.
If Trump’s additions to the debt become truly problematic, we’ve probably got a year or two before the trouble begins. “I’m expecting a sugar high over the next 6 quarters,” says Brusuelas. “But we ought to know by 2019.” By then, the Federal Reserve will have signaled whether it feels more aggressive monetary tightening is necessary to deal with the corrosive effects of too much debt. If it does, it could make the latest selloff seem tame.
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Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman