Bankruptcy Is Our Only Hope

By Kevin D. Williamson

Friday, October 16, 2015

It’s an ill financial wind that blows no one some good. A very nice and very rich old lady once explained to me that, in her view, the golden age of the American economy happened in the first years of the Reagan administration. This puzzled me: The United States had dipped into recession in 1980, and Paul Volcker was standing on the economic brakes to wring the Carter-era inflation out of the economy, jacking the federal-funds target rate up to damned near 20 percent. People were paying 18.5 percent on their mortgages. But, of course, usurious interest rates are pretty awesome if you’re an old lady with a bank vault full of T-bills. You get 12 or 14 percent returns with effectively no risk.

Right now, we’re in the opposite situation, one where savers are suckers. If you bought ten-year Treasuries in October, you got a rate of 1.99 percent — which is about 400 basis points less than inflation is expected to average over the next ten years. You aren’t giving Uncle Stupid an interest-free loan — you’re paying for the privilege of lending Washington your money. Of course, that’s big money compared with the 0.03 percent APY you’re getting on your savings account, or, if you’re a big-money private-banking client, the 0.08 percent. Put $1,000 into a savings account today and you’ll have $1,349.80 — in a thousand years.

With real interest rates hovering around the point known among theoretical mathematicians as jack squat, it’s a great time to be a debtor. And Uncle Stupid is the biggest debtor of all, with $18 trillion or so in official debt, and a hell of a lot more if you play by something resembling normal accounting rules. Janet Yellen keeps making squeaky little noises about the Fed moving to raise rates in the direction of non-zero, but with economic growth stagnant and no general inflation to be seen at Walmart, there’s not much incentive to raise rates. And if and when the Fed should decide it really needs to raise rates, there’s that $18 trillion-and-growing pile of debt waiting to prison-rape American public finances.

Don’t say nobody saw this coming. Everybody sees this coming.

Reversion to the mean is a bitch. If we assume that nothing has magically transformed the nature of debt and finance in the past decade or so and that interest rates will, eventually, move back toward normalcy, we might want to run some numbers. For the sake of simplicity and terror-avoidance, let’s say that the debt doesn’t grow, that it just sits there at $18 trillion. If interest rates on the federal debt should return to their level in 1995 — not some weird exotic point in the past but back in the Clinton years — then we’re going to be paying $1.4 trillion a year just in interest on the existing debt; which is to say, interest payments alone will account for 45 percent of all federal taxes that will be collected in 2015.

Does it get worse? Of course it gets worse. If interest rates should return to their 1982 levels — there’s no reason to think they’re on the verge of doing so, but there’s also no reason to think that it is impossible — then we’ll be paying $2.6 trillion a year in interest payments alone. That’s 84 percent of the taxes the federal government will collect this year.

At Clinton-era rates, we’d be spending on interest alone about 2.5 times what we spend on the military right now. At early Reagan-era rates, we’d be spending on interest alone about what we spend now on national defense, Social Security, Medicare, and Medicaid put together — the whole welfare-warfare enchilada, basically.

And, strictly speaking, there is no economic reason to believe that historical extremes are the limit on where interest rates can go. Interest rates on government debt are driven by two things: how credible investors think your fiscal story is and what other options they have. As the world grows richer, there will be a lot of low-risk government instruments available to soak up all that money sitting in U.S. government bonds.

My hope is that when this crisis comes — and it almost certainly is coming — it will prove an instrument of free-market reform. (You can read a lot more about that here.) Washington may and should and really must do some proactive reform, particularly to entitlements, in the here-and-now, but it’s a safe bet that the big hairy stuff like privatizing retirement and health care entirely isn’t going to happen until Washington is left with no other options. The sort of reforms that are likely to happen in the next ten years or so will not prevent a crisis, but, if done right, they will give us some say over what sort of crisis we have: a slow, low, manageable one or a short, sharp, ruinous one.

Some of my conservative friends believe that we’re going to be rescued by the Growth Fairy. I believe in the Bankruptcy Fairy.