As interest rates inch up, America will be paying more and more to support its borrowing habit.
Problems with stimulants include the hangover that follows the high, the compulsion to keep chasing that initial feeling despite all subsequent attempts falling short, and the Charles Atlas self-portrait that others see as the guy getting sand kicked in his face. One pays a price for taking anything, including stimulants. Nothing comes for free, especially money.
A decade ago, economies jonesing for a boost received it in the form of quantitative easing. Governments and central banks concerned about deflation and depressions lowered short-term interest rates and purchased long-term maturities. The Federal Reserve, for instance, purchased debt and tripled its balance sheet from $1.5 trillion to $4.5 trillion.
As once-staggering economies now expand, governments and central banks move toward a deference to supply and demand determining rates and central banks acting as, well, central banks and not private investors in the financial markets. Increasing chatter calls this “quantitative tightening.” But it really needs no label. It just represents a turning away from the new normal toward the historical norm.
U.S. Treasury notes currently hover around three percent. With inflation at about two percent, the “real” interest rate comes in at about one percent. This figures to rise, with economists forecasting the real interest rate to settle at two percent. This eclipses recent rates but still appears low, historically speaking.
The European Central Bank recently announced a cessation of its bond-buying program by the end of this year. The ECB plans to continue offering a negative interest rate through next summer. The ECB’s current deposit rate falls into the negative category. The key lending rate remains zero percent. The ECB signaled that this ends soon.
Changing circumstances change policies, which change circumstances.
As the cost of borrowing grows more expensive, the world’s leading borrower faces difficult but necessary choices.
With the United States government $21 trillion in debt and deficits for the first half of fiscal year 2018 nearly reaching $600 billion, the rise in interest rates profoundly affects budgetary matters. Each one percent increase in the interest rate amounts to more than $200 billion more in the cost of the federal government servicing its debt. In other words, the federal budget experienced a massive budget increase in the last year without a single legislator voting for it. But by habitually voting to carry more debt, legislators in effect voted for it.
Congress possesses some control in responding to a situation it holds little control over. It could institute a new tax, perhaps a value-added tax like that experienced in European Union member states. It could cut spending, perhaps focusing on the largest, and fastest growing, area of the federal budget: healthcare. It could decide not to decide — decisionmaking of the likes it excels at — by borrowing more money at higher rates. This last option helps ensure that at some point the government explores one or more of the first options at a later date.
The American addiction to borrowing, facilitated by rock-bottom interest rates, seemed painless. But with the Office of Management and Budget projecting interest payments on the debt rising from about one of every 13 dollars spent in the budget now to about one of eight by the middle of the next decade, that addiction to borrowing hurts spending priorities and ambitions to provide tax breaks.
Kicking a habit involves a lot of pain. The more one delays addressing the problem, the more pain one experiences.