An All-Consuming Interest

By John Lumbard


In my last post I suggested that we shouldn’t count the U.S. Treasury bonds held in the Social Security trust fund when talking about the size of the debt.  The reason is that we don’t have to pay any interest on the bonds in the trust funds—they’re really just a fiction, in a system in which today’s workers pay for today’s retirees with today’s taxes.

And it’s not really the size of today’s debt that matters, because—over the course of your lifetime—the interest on that debt will be many times as large as the debt itself.  Our annual  interest payments will grow as the debt grows, and they will accelerate when interest rates rise.  The Congressional Budget Office projects that the government will pay interest of just $207 billion in 2010, because most of today’s debt is borrowed via Treasury bills that yield 1% or less.

Short-term interest rates can skyrocket.  In March of 1980 Treasury bills hit 16.5%, and it’s not hard to imagine a scenario in which we have to pay higher interest rates to entice foreign investors who have become fearful of forecasts of huge deficits stretching far into the future.  If we have to pay an interest rate of just 8% on a debt of $13 trillion, we’ll find ourselves paying a trillion dollars a year in interest—and the same would be true if we had to pay 10% on the $10 trillion debt that the CBO expects in the spring of 2012.  At the moment the CBO is projecting that our interest costs will rise very slowly, causing smaller deficits (that are further reduced by forecasts of unlikely budget cuts provided by the Congress);  but it’s much more likely that interest rates will rebound from these abnormally-low levels.  Bigger interest costs will beget bigger deficits and a larger debt, and thus even larger interest rates . . . . .

Some time in the next 2 years we have to present to foreign investors—the people who are keeping us afloat— a credible plan for balancing our budgets and stopping the growth of our debt.  If we wait too long, interest rates will rise, and our debt will spiral out of control.

This year the federal government will take in $2.2 trillion in tax revenue and spend $3.5 trillion, even though these projections only include $207 billion in interest.  It’s hard to imagine that our irresponsible Congress would be able to cope with an interest cost of $1 trillion a year.

We’re not going to solve this problem if we start by proposing specific spending cuts and tax increases.  Every tax break is protected by a fierce army of constituents, and the same is true of every fast-growing entitlement.  Your representatives in Congress will balance the budget only if they have no choice, and that means handcuffing them with laws and constitutional amendments.

One set of handcuffs might not be enough, because Washington is full of smart people whose primary interest in life is winning the next election—even if that means buying votes with Other People’s Money and mortgaging the future of our children.  Please help us encourage legislators and candidates, from both political parties, to take our Pledge of Fiscal Responsibility.  We don’t know of any other way to escape the vicious spiral that lies ahead.



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