Inflation and deficits do not diminish the attractiveness of US bonds
Bernstein has stipulated that while debt financing has its place, the White House also believes it has firm limits in its program. “The result of all of this is going to be a mix of incrementally increased revenues and investments in essential public goods with a high return financed by debt.”
Look forward and to the past
What would have to happen for these low borrowing costs to rise significantly? There could be a crisis of confidence in Fed policy, a geopolitical crisis, or big hikes in key Fed rates in an attempt to kill inflation. In a more easily imagined situation, some believe that if inflation remains close to current levels in the second half of the year, bond buyers could lose patience and scale back their purchases until yields are more in line with the rise. prices.
The resulting higher debt interest payments would force budget cuts, said Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget. Mr. Goldwein’s organization, which pushes for a balanced budget, valued that even with last year’s low rates, the federal government would spend more than $300 billion on interest payments — more than its 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 an article titled “How higher interest rates could push Washington toward a federal debt crisis.” It concludes that “debt is already expected to reach unsustainable levels even before new proposals are adopted”.
The offsetting global and demographic trends that have driven rates down, Reidl writes, are an “accidental, and perhaps temporary, subsidy to federal lawmakers who borrow heavily.” Assuming these trends continue, he said, it would be like becoming a self-satisfied football team that “managed to improve its overall win-loss record over several seasons – despite a rapidly deteriorating defense – because his offense continued to improve enough to barely outclass. his opponents. »
But at least one historical trend suggests that rates will remain moderate: an overall decline in real interest rates around the world for six centuries.
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 have globalized, innovated and matured, the flaws in payment among the safest borrowers – strong governments – have steadily declined. According to his article, one of the ramifications could be that “regardless of particular monetary and fiscal responses, real rates may soon enter permanent negative territory,” producing less than the rate of inflation.