Editors’ Note: One of the least discussed subjects is the incredible and dangerous distortions in the US economy. A powerful rising stock market has obscured the problem. Recently, we have registered another strong breakout to the upside. But we have often cautioned not to conflate the stock market with the economy. They are connected over time through both corporate earnings and the health of consumers, but stocks react more in the short term to available liquidity, interest rates, and investor sentiment. Despite the signals from equities, the country has serious financial issues. This is true at the Federal level, but also many states and cities are highly indebted, as is the consumer. If the economy slows down, the revenue stream to support that debt is called into question. However, if Republicans succeed at the polls and take charge, they will be taking over a country that is financially highly leveraged, after years of zero interest rates and monetary and fiscal stimulation on a scale never before seen in US economic history. The Biden Administration has used monetary steroids to revive the economy but such high doses of stimulus cannot be financially sustained. However, to tame runaway deficits will require that fiscal stimulation be reduced sharply. This puts Republicans in a bind. If they are serious about fiscal responsibility, the steps they must take initially could slow the economy, exposing this debt burden. Tax cuts and swift deregulation are their best hope to replace artificial money printing stimulus with the stimulus of true incentives to work and produce. But, under such extreme circumstances, necessary fiscal discipline runs the risk of weakening an economy already staggering under the heavy weight of unsustainable debt.
Federal Reserve chair Jerome Powell once again warned earlier this month that the U.S. government’s fiscal policy is on an unsustainable path.
His new warning came at a forum held by the European Central Bank in Sintra, Portugal, on July 2, 2024. The Financial Times’s Martin Arnold reports:
Jay Powell warned that the Biden administration was taking excessive risks by “running a very large deficit at a time when we are at full employment” and said “you can’t run these levels in good economic times for very long”.
It’s not the first time Jerome Powell has issued such a warning. The previous warning was in October 2023. However, unlike then, Powell’s new comments made a distinction: “The level of debt we have is completely sustainable, but the path we are on is unsustainable.”
On July 2, the U.S. government’s total public debt outstanding stood at $34.87 trillion, which is a very big number. If that level of debt is sustainable, as Powell claims, how is the path the U.S. government on unsustainable? How can both things be true at the same time?
The answer to that question has everything to do with interest rates and the U.S. government’s excessive spending.
Because of its excessive spending, the U.S. government is not able to fully retire its debt as it comes due and reduce the total amount. Instead, it has to borrow even more to cover its new spending. It must also roll over debt for money it has previously borrowed and cannot fully pay off. Worse, it is doing all that at today’s interest rates, which are higher than when the debt being rolled over was borrowed.
ADVERTISEMENT
What makes that problem unsustainable is that excessive federal government spending contributes to inflation. The inflation unleashed by U.S. politicians in recent years forced the Fed to respond by hiking interest rates to get it back under control. Today’s modestly elevated interest rates make today’s excessive spending unsustainable.
If excessive government spending were brought under control, however, it would make the Fed’s job of fighting inflation easier. Interest rates could come down, which, if they did, would make it more possible to sustain such a large national debt. That’s the point Powell was making.
The only problem is that few in Washington DC are interested in reining in the U.S. government’s excessive spending. Until they do, the U.S. government’s fiscal policies will remain unsustainable.
*****
This article appeared in The Beacon, a publication of the Independent Institute, and is reproduced with permission.
