Daniel Altman

The Doomsayers Are Wrong Again

The Doomsayers Are Wrong Again

In the waning days of 2010, with President Obama’s stimulus package in full swing in the United States, the interest rate doomsayers were already wringing their hands. The government could manage its borrowing for the time being, they said, but rates would soon rise and make the national debt unsustainable. Three years later, that hasn’t happened, yet the doomsayers haven’t changed their tune. Will they be wrong again?

In December 2010, the Congressional Budget Office issued a report entitled "Federal Debt and Interest Costs." At the time, the federal government’s interest payments had fallen to their lowest level, as a share of GDP, since the 1970s. How was this possible, given the ballooning size of the national debt? In two words: relative value. Investors were desperate for solid, safe assets, and there wasn’t much competition from other securities in the wounded, languid markets. So the United States was able to borrow at some of the lowest rates in history.

As the interest rate doomsayers pointed out, this was possibly a temporary situation. If interest rates rose, the United States would be forced to roll over its debts at higher rates; paying interest on time would become much more difficult, if not impossible, unless the overall level of debt were reduced. The CBO was sure that this dark day was coming, and said so in the abstract of its report: "The interest the government pays on that debt is currently low by historical standards as a percentage of GDP but is expected to grow rapidly over the next several years as interest rates rise."

It didn’t happen. Since December 2010, interest rates have actually fallen from about 3.3 percent for 10-year Treasurys to 1.9 percent at the time of this writing. The rates were already low in 2010; now, having dropped as low as 1.5 percent last summer, they’re still close to rock bottom.

So why were the interest rate doomsayers so wrong? It’s not as though Congress and the White House reached any sort of grand bargain to reduce the nation’s debt between 2010 and 2013 — quite the contrary. But during that time, forecasts for the national debt did decrease somewhat because of projections for health-care costs. They fell enough that by 2020, Medicare and Medicaid were expected to cost about $200 billion less per year than the CBO had forecast in March 2010. Also, the Republicans in Congress may have succeeded in blocking more fiscal stimulus, but it’s not clear that the credit markets expected any new stimulus measures to pass in the first place.

No, the handling of the nation’s fiscal situation probably had very little to do with the path of interest rates. So what did happen? It wasn’t the federal government’s demand for credit that drove the changes; it was the supply.

Despite the manufactured debt ceiling crisis in 2011 and the general dysfunction in Washington, investors were more than happy to pour billions of dollars into the Treasury’s coffers. Some of them came from developing countries where rapid growth continued to generate profits and surplus tax revenues in search of safe homes. Amid the enduring uncertainty in the global economy, the American taxpayer was still seen as one of the world’s best bets. At the same time, the Federal Reserve continued to pump new money into the markets. By committing to do so for several more years, it ensured that credit would remain cheap for the public and private sectors.

Today, the interest rate doomsayers are still shrieking about the government’s demand for credit. They say Washington must cut spending now in order to reassure the markets that the United States will be able to pay its debts in the long term. "The US will reside in the debt danger zone for the foreseeable future in the absence of action," wrote Douglas Holtz-Eakin, a former director of the CBO.

These fears are overblown. The Treasury could double the interest payments on every single bond, note, and bill outstanding today, and the overall cost would still be lower as a share of GDP — about 2.8 percent — than at many times in the late 1980s and early 1990s.

Granted, interest rates in the markets can change quickly (just ask any European finance minister), but interest rates on the entire federal debt can’t change that quickly. The reason, as I’ve pointed out here before, is that the Treasury has been steadily lengthening the term of its borrowing. This means those debts don’t roll over nearly as often as they used to, and the country has more time to plan for changes in interest rates.

Moreover, the markets likely believe that the debt will come down naturally, for reasons that Nobel laureate Robert Solow recently pointed out in an op-ed for the New York Times. When strong growth returns to the American economy, tax revenue will rise and debts will be paid off, making more room for private borrowing.

For now, however, growth is sluggish and investors are still eager to buy American debt; the Treasury’s last auction for 30-year bonds was almost three times oversubscribed. With the eurozone in trouble and Japan pursuing higher inflation, there are few safe places to park one’s money. Yet a recovery in the eurozone or an eventual return to price stability in Japan won’t bring on any sort of debt crisis in the United States. Either of those would signify a return to growth abroad, which would create demand for American goods and services as well. Faster growth in the United States would lead to smaller deficits and a smaller-than-expected national debt.

Under these circumstances, the interest rate doomsayers would be wrong again. Problems abroad are holding back growth in the United States (as are premature budget cuts here at home, according to Solow). As long as they do, the Fed will keep flooding the markets with money, investors will keep flooding the Treasury with money, and interest rates will stay low. When the problems abroad sort themselves out, interest rates may indeed rise — but the national debt will shrink at the same time.

None of this will come as any surprise to people who work on Wall Street instead of in Washington. Financial analysts and economists don’t see any urgent threat of higher interest rates or unsustainable debts; if they did, then interest rates on Treasury securities would already be higher today. No, the only threat is the one that people in Washington have conjured up to justify deep cuts in federal spending. Why would anyone listen to them?