Say nothing about the kids… Debt and Disaster in Our Generation

February 17, 2010

By David J. Gernhard

The government is often compared to fire: a dangerous servant and a fearful master. We could extend the analogy by saying that a government financed by debt is equivalent to dousing the fire with gasoline. A survey of the current state of U.S. debt conjures up images of flames following pouring accelerant back into the can, exploding at terrible cost to life and limb—an apt metaphor for the present effects of our national debt.

Government debt is not merely detrimental to the future, as many argue; its harmful consequences are occurring all around us today.

Government debt harms businesses and disrupts market allocation. Here’s how:when the government borrows from the public through the sale of treasury bills, notes, and bonds, it attracts credit away from businesses and firms. These firms, in order to compete with the (perceived) safety found in government debt, must offer their bonds at a higher interest rate. Consequently, the cost on private borrowing is raised and many private borrowers are no longer able to afford to borrow money. Government debt crowds out private borrowing.

So, what does the government do with the money that would otherwise have gone to profit-earning firms? It is used to finance all the government projects we know and love.

The funds raised by government bond sales — rather than being allocated according to demonstrated consumer preference into the hands of entrepreneurs that know how to use it — are allocated through the political process of backhanded deals, earmarks, and special interests.

The bureaus that receive these funds use them to bid present resources out of the private sector. For example, NASA uses government money to hire scientists away from private companies. As a result, a company like Boeing must offer a higher wage to attract those scientists back into the private sector. National debt makes Boeing, and all other businesses, less competitive.

Government debt then has a two-fold effect on the present economy: it increases the cost of borrowing for private firms and it provides government with money to bid present goods and services away from those same firms.

These harms are compounded by the present situation of the United States where10% of the national budget is spent paying merely the interest on national debt. This is with interest rates near all time lows! If interest rates were to rise, it would quickly take more than 10% to cover the interest rate charges on government debt. Consider an increase in rates from 2% to 4%. This would double the amount of money needed to simply meet the interest cost of debt from 10% of our budget to 20%. What about an increase from 2% to 10%? 50% of the budget would be spent on servicing the debt.

How can the United States afford to spend 50% of its budget on interest payments? It cannot. If interest rates were to reach these levels, the government would face only three options: a) a drastic cut in spending and an increase in taxes, b) repudiation of the debt either directly or through inflation, or c) a combination of repudiation and revenue creation.

It doesn’t take generations for interest rates to rise, either. Government debt is sold in different maturity lengths, but the average maturity of all government debt is 48 months. State planners try to balance when bonds and bills mature to even-out the refinancing schedule, but when interest rates rise, it will take only a couple of dozen months for all of our debt burden to refinance at these higher rates, putting a tremendous strain on the budget. At that point, drastic action will have to be taken.

Our giant debt burden is sucking private credit out of our economy, it gives government the ability to finance projects and hire resources away from free enterprise, and it puts the US in a precarious position. A budget surplus that can pay off the debt is the only prudent approach. It should be adopted soon, not only for the sake of future generations, but for this generation too. The United States is fooling itself if it thinks it can play with fire without getting burned.