To many global investors, the almighty dollar isn’t looking quite as almighty these days, in part because America’s fiscal situation has deteriorated significantly. This fiscal challenge holds one of the keys to the Trump administration’s goals on trade, as the United States will not succeed in reducing its trade deficits materially unless it also reduces its budget deficit.
For years it was reasonable to tune out the worrywarts carping about deficits. With very low interest rates, a lack of particularly attractive alternatives to U.S. Treasuries for investors and a muted market reaction to serial Capitol Hill dramas over raising the debt limit, those who bemoaned the unsustainability of deficit spending and debt levels seemed to cry wolf — a lot. Even as a former White House budget director, I grew skeptical of their endless warnings.
Not anymore.
Two things have changed: First, the wolf is now lurking much closer to our door. Annual federal budget deficits are running at 6 percent of G.D.P. or higher, compared with well under 3 percent a decade ago. Interest rates on 10-year Treasuries have more than doubled — around 4.5 percent now versus just over 2 percent then — and in the current fiscal year the government is projected to spend more on interest payments than on defense, Medicaid or Medicare. That’s right: Our borrowing now costs us more each year than each of these big, essential budget items.
Meanwhile, federal debt held by the public, excluding Federal Reserve holdings, as a share of G.D.P. has increased by about a third since 2015. The Congressional Budget Office, which I once led, projects that by 2029, our debt as a share of our economy will grow to levels unprecedented since the years after World War II. All of this is occurring against a backdrop of an even more polarized political system, increased tension with foreign debt holders and less confidence in American security protections that promoted the dollar as the world’s safe haven.
The risks posed by our heavily leveraged government are higher today than in the past, but it’s also true that none of the feared adverse effects have happened — yet. It is hard to find any modern economy with a freely floating exchange rate and debt denominated in its own currency, both of which the United States enjoys, that has defaulted on its debt. So why raise alarms now?
Because the absence of evidence is not evidence of absence. No other nation has had the combination of factors defining America’s current fiscal position, so precedent is not helpful.
