Biden’s Trillions Are Not a Problem
By Nayyer Ali MD
Joe Biden, who took office this week facing a host of massive challenges, has proposed spending another two trillion dollars to get America out of the economic and medical devastation of the COVID pandemic. This is on top of the two trillion Congress allocated last April and the 900 billion that Pelosi and McConnell agreed to and passed three weeks ago. Combined, the US Federal government will have pushed almost five trillion dollars, a sum equal to 25% of GDP, out the door in the last year.
It has been this aggressive government spending that has kept the economic damage tolerable, and even the 10 million or so unemployed have gotten stimulus checks and enhanced unemployment benefits that have helped immensely. But this kind of spending makes many uneasy. Isn’t there a limit to this sort of thing? Who pays for this in the end if the government is covering the cost by borrowing five trillion dollars, which is exactly what it has done?
To understand this requires understanding the difference between household debt and government debt, which are two very different things. A person who borrows lots of money has to consider how long they will live, and how many more years they will work, and how much money they will make. They realize that they must pay the debt off completely in a reasonable time, no bank is making a thirty-year loan to an 85-year old person. Conversely, the lender must look carefully at the borrower to decide how much interest to charge for the loan. Is there a chance the borrower will refuse to pay the money back? Is there any collateral pledged toward the loan? Does the borrower have a steady job and stable income? Will the borrower get sick or have a messy divorce that prevents them from paying back the loan? All these factors impact the amount of money a person can borrow, for how long, and at what interest rate.
A credit card debt that has no collateral comes with a very high interest rate, while a home mortgage which allows the lender to repossess the home comes with much lower rate. In short, the interest rate reflects the risk of non-payment on the debt.
A country is a different thing entirely. It goes on forever, never loses its job, and is always good for the money, as it can print the currency if it needs to. This is why government debt carries the lowest interest rate of any debt in the economy, because it is essentially risk-free. The only risk with government debt is inflation. If a lender gives the government a loan for 10 years, it wants at least the full value of its money back at that future time. This is why in general, government debt carries an interest rate that is roughly in line with expected inflation. Because we don’t know the future, debt for six months will still carry a lower interest rate than 10-year or 30-year debt, where a higher rate reflects the uncertainty about possible higher inflation in the future. Currently, the US government can borrow for two years or less at about .1%, 10 years at 1%, and 30 years at 1.9%. Current inflation is running at 1.7%.
So when will the government have to pay back the 5 trillion borrowed to fight the pandemic’s effects? The shocking answer is never. While individuals die, nations do not, so there is no endpoint at which the government needs to pay off its debts. The burden of debt is always in relation to a person’s or nation’s income. If a person borrows 100,000 dollars while working minimum wage, they will be in trouble, but if they borrow that while they make 500,000 dollars per year as a lawyer, they are not. Same for a country. But a country increases its economy (income) every year through both real growth and inflation. This leads to a nifty insight. If the rise in the economy is faster than the interest rate on the debt, than the debt shrinks in significance. Currently, the US government pays less than 2% interest on its debt, while the economy on average grows 4% per year. Even with the massive spending of the last 12 months, the government will owe about 120% of GDP in debt. But over 10 years of paying 2% interest while growing 4% per year, the debt will rise 22% while the economy grows 48%, and the value of the debt shrivels to 99% of GDP. For this magic to happen, the government doesn’t even need to balance its budget, it just needs to restrict the new borrowing to money needed to cover the interest payments. As a matter of public policy this is a simple choice and can easily be done. In normal times the Federal government spends about 20% of GDP, and we have in the past set taxes to raise over 20% of GDP (as recently as 1999). If the Trump tax cuts are reversed that alone would almost get us there.
There is a second element that also plays a big role in funding the pandemic relief that is not being appreciated. That is the Federal Reserve’s decision to buy 3 trillion dollars of bonds, a feat done by electronically printing money, which is its superpower. The Fed did this in about 60 days, between March and May 2020. It did a similar thing during the aftermath of the Great Recession, but that time it bought three trillion dollars over six years. This electronic printing press basically gave the government a free lunch. It funded the cost of the first COVID relief bill entirely with printed money, and did not actually have to borrow from the private sector. The bonds are legally owned by the Federal Reserve, but since that is a branch of the government, all interest payments on those bonds are sent back to the US Treasury, so essentially they are interest-free money. Isn’t this illegal? No, in fact it is being done by all the major central banks to stimulate their economies by keeping interest rates low and allowing governments to spend freely.
For many, debt has a moral element to it. To take on debt is a failure of some sort, and debtors should suffer punishment for it. But that’s not how central banking and modern economies work. At some level money printing has negative consequences, and can lead to runaway hyperinflation. But we are nowhere near there. The national debt in 2019 was at 80% of GDP, and COVID spending has pushed it up to about 120% of GDP if we include Biden’s plan, but if we don’t count the debt purchased by the Federal Reserve, it would push that number back down to 85% of GDP (the Fed holds about 7 trillion dollars in debt currently). At some point those bonds will be paid off, but it will be up to the Federal Reserve if it wishes to make the cash then disappear electronically, or use it to buy new bonds and keep its portfolio at 7 trillion dollars. After 2014, when the Fed stopped buying bonds, it would still buy new ones to replace old bonds that were paid off by the Treasury, keeping its balance sheet steady.
How much debt can the Federal Reserve buy without triggering inflation? We don’t know. The Japanese though provide some insight. For the last two decades they have been repeatedly trying to stimulate their slow-growing economy with government spending financed by debt that is purchased by the Japanese Central Bank, which is to say they have printed the money. At this point, Japan’s debt has reached 266% of GDP, more than double the US number. But the Bank of Japan owns half of that debt, so Japan’s real public debt burden is only 133% of GDP. And what does Japan pay in interest on its debt? Even less than the US.
The bottom line is that vague debt fears relying on poor mathematics should not deter Biden from aggressively tackling the current economic and medical crisis. Getting the country healthy and back to full employment is the priority. In the long run, we need to tax ourselves as a nation at a level equal to what we want to spend. But we don’t need to raise tax dollars to pay back debt, or even to pay the interest on the debt. Just paying for current spending in the long run (called primary balance), is sufficient to reduce the debt burden over time. And a nation has all the time in the world.
