Higher Interest Rates Could Spark a Debt Crisis: Report

Higher Interest Rates Could Spark a Debt Crisis: Report

U.S. Senate Majority Leader Schumer holds news conference at the U.S. Capitol in Washington
By Yuval Rosenberg and Michael Rainey
Wednesday, December 22, 2021
We’re calling it a year. We'll be back in your inbox in 2022! Until then, send your feedback to yrosenberg@thefiscaltimes.com. And as always, please encourage your friends to sign up for their own copy of this newsletter.

Happy and healthy holidays to you all, and best wishes for the new year!

A Festivus for the Democrats

Festivus isn’t until tomorrow, but Cowen Washington Research Group analyst Chris Krueger writes that Senate Democrats started celebrating early, using a private caucus call on Tuesday night for an airing of grievances over their $1.7 trillion climate and social policy plan and Sen. Joe Manchin’s announcement Sunday that he can’t support the bill.

Senate Majority Leader Chuck Schumer reportedly reiterated to his members that he plans to hold a floor vote on the Build Back Better (BBB) bill next month, forcing Manchin to officially give a thumbs-down to the package.

"I know we are all frustrated at this outcome," Schumer said, according to Politico. "However, we are not giving up on BBB. Period. We won’t stop working on it until we pass a bill."

Manchin reportedly also addressed his fellow Democrats and again laid out his concerns, saying that his position has been the same for five months. "Manchin also called for a greater focus on tax rates, adding that the rich need to pay more in taxes, and said the Department of Veterans Affairs should negotiate drug pricing," Politico’s Marianne LeVine reports.

The bottom line: Democrats will work on building back their Build Back Better bill. Krueger suggested in a note to clients that a revised version of the legislation could be centered on four elements: expanded Affordable Care Act subsidies, universal pre-k, climate provisions and tax increases to offset the cost of proposed new spending. "We believe something will emerge and be enacted into law by the Memorial Day Recess," he wrote, "though it is an impossibly fluid situation."

The process, he added, will likely see Democrats spend months on another Festivus tradition: "Feats of Strength between Biden, House & Senate Democrats."

Quote of the Day: Wooing Joe Manchin

"Why in the world would they want to call him a liar and try to hotbox him and embarrass him? I think the message is, ‘We don’t want you around.’ Obviously that is up to Joe Manchin, but he is clearly not welcome on that side of the aisle.

— Republican Senate Minority Leader Mitch McConnell of Kentucky, talking to Carl Hulse of The New York Times about the clash between Democratic leaders and Sen. Joe Manchin (D-WV). McConnell, who has reportedly tried to get Manchin to change parties for years, said he was shocked by the way the White House responded to Manchin’s refusal to support the Build Back Better Act, which contains much of President Jos Biden’s domestic agenda. "Obviously we would love to have him on our team," McConnell said. "I think he’d be more comfortable."

Higher Interest Rates Could Spark a Debt Crisis: Report

The world has changed, Treasury Secretary Janet Yellen told Congress early this year. She wasn’t talking about Covid, though. She was arguing that an era of persistently low interest rates meant that the United States could afford to carry more debt — and to spend as needed to address the pandemic and make long-term investments to grow the economy. "In a very low interest-rate environment like we’re in, what we’re seeing is that even though the amount of debt relative to the economy has gone up, the interest burden hasn’t," Yellen said.

As we end the year, the debate over that line of thought, which has emerged as the conventional wisdom underpinning much of liberal economic policymaking, is still going on, with fiscal hawks warning that increases in interest rates could still lead to a debt crisis and conservatives pushing back against the prospect of deficit-financed government expansion.

The latest such argument against downplaying debt fears comes from Brian Riedl, a senior fellow and veteran budget expert at the conservative Manhattan Institute. In a new 32-page report, Riedl warns that the newly popular line of economic thinking "has two fatal flaws":

"First, it fails to acknowledge that over the next few decades—even without new legislation—the debt is already projected to reach levels that even debt doves would likely consider unsustainable. Second, this argument assumes that interest rates will forever remain near today’s low levels, thus minimizing Washington’s cost of servicing this debt."
Riedl argues that the government is already projected to run baseline deficits totaling $112 trillion over the next three decades, with annual deficits rising to more than 13% of the economy and the national debt growing to more than 200% of GDP. Interest payments at that point would eat up almost half of all tax revenues. "In short," Riedl writes, "the baseline debt is already projected to grow to unsustainable levels even before any new proposals are enacted."

If interest rates rise, the fiscal outlook would be even worse. The Congressional Budget Office projects that the average interest rate on the federal debt will rise from 2.4% in 2019 to 4.6% by 2051. Riedl writes that economic forecasters have been "disastrously wrong" in their predictions — though in recent decades, they’ve mostly overestimated where interest rates would be. Still, he says, it’s dangerous to assume that rates will stay low forever, and some of the factors that have kept them this low for this long could reverse themselves: "Indeed, several realistic economic scenarios could easily push interest rates back up to 4%–5% within a few decades—which would coincide with a projected debt surge to greatly increase federal budget interest costs."

Even if rates only rise in keeping with CBO’s projections, interest costs on the debt would grow to 8.6% of GDP by 2015, becoming the largest expenditure in the federal budget. And the risk from rates rising even higher would be severe, as government interest costs would climb by $30 trillion over 30 years for every percentage point rates rise above the CBO forecast. "In short, once the debt surges, even modest interest-rate movements can impose stratospheric costs," Riedl warns.

The bottom line: "The big takeaway," Riedl writes in an email, "is that lawmakers should not gamble the long-term economy on the hope that interest rates never exceed 4% or 5% again. Because there is no backup plan if they’re wrong."

Read his full report here.

Food Insecurity Rising as Child Tax Credits End: Census

More than 21 million people in the U.S. lacked sufficient food in early December, according to data from the U.S. Census Bureau reported by Bloomberg News Wednesday.

In the first two weeks of the month, about 9.7% of households reported not having enough to eat, a five-month high. The number of such households fell sharply starting in August, as the first child tax credit payments were issued. Experts worry that the number will only move higher to with the end of the payment program, which expires at the end of the year. An extension of the program was included in the Build Back Better Act, which now faces an uncertain future.

Soaring food prices are a major contributor to rising food insecurity, with inflation pushing food prices up by 6.4% on a year-over-year basis. "Food banks are also seeing a rise in demand," says Bloomberg’s Ella Ceron, "and clinics meant to help malnourished and underfed children have seen an increase in patients."


Views and Analysis