Is the U.S. Really on the Brink of Budget Collapse?

Is the United States government facing “fiscal suicide?” Are U.S. Treasury Bonds “heading for the dumpster?” Such claims have been published regularly in the mainstream media following the passage of the Obama economic stimulus program, which became law last February (these particular quotes were in the New York Times and Bloomberg News last May). Of course, the Obama stimulus program was implemented to counteract the economic disaster that was already at hand as of last February and continues to the present.

In fact, the stimulus program is too small relative to the magnitude of the crisis and too loaded with corporate tax breaks. But it is still among the most progressive pieces of economic legislation since the 1960s. Of the $787 billion total in new government spending being pumped into the economy over the next two years, major funds are flowing into clean energy and traditional infrastructure investments, health care, and education, as well unemployment insurance, food stamps and similar measures to support people who are suffering most severely from the crisis. Overall, the stimulus program aims to generate about 3.5 million jobs over the next two years, to compensate at least in part for the nearly 7 million jobs the economy has shed since January 2008.

Good intentions aside, the Obama program will obviously not succeed if it ends up wrecking the U.S. government’s financial credibility. This is why—like it or not—debates over the deficit cannot be left to technicians and Wall Street fulminators alone. Ordinary people, progressives in particular, need to maintain a basic grasp of the issues at hand.

In fact, government bonds are not really heading for the dumpster. We can see this over the short term by considering the government’s forthcoming interest payment obligations. Over the longer term, the most fair and effective ways to control government deficits will entail raising taxes on the wealthy, in particular Wall Street speculators, and cutting the gargantuan sums of money that now flow to both to the health care industry and the military.

Low Interest Rates Mean Small Debt Payments

To pay for the Obama stimulus program, the U.S. fiscal deficit is projected to rise to $1.8 trillion in 2009 and $1.4 trillion in 2010. The 2009 deficit amounts to about 13 percent of projected GDP in 2009, with the 2010 deficit at 10 percent of GDP. Over 1942 – 46, as the U.S. fought World War II, the federal deficit averaged 19.2 percent of GDP, peaking in 1943 at 30.3 percent. The 2010 deficit will be by far the largest since World War II. The closest we have come previously was in 1982, during the recession under Ronald Reagan, when the deficit reached 6 percent of GDP. For the full postwar period, the fiscal deficit averaged about two percent of GDP.

In assessing the fiscal burden that these deficits will create, we need ask the same question a household would pose when taking out a mortgage, which is: how much will we have to pay every month to service our new debt? In fact, the news is very positive, at least for the next few years.

For the first six months of Obama’s Presidency, the interest rate on 5-year U.S. Treasury bonds averaged 2.1 percent. By contrast, when the Reagan-era deficits peaked in 1982, the government paid, on average, 13 percent for 5-year Treasuries. This difference in interest rates between the Reagan-era deficits and now completely transforms the fiscal picture. Assuming the average interest rate on government debt is at the 5-year bond rate of 2.1 percent, the government will have to pay about $38 billion per year in interest on the projected 2009 deficit of $1.8 trillion. If the interest rate had been at Reagan-era levels of 13 percent, the annual interest payment on $1.8 trillion would have instead been $234 billion. The current low interest rates thus reduce the government’s debt burden by nearly $200 billion per year, an amount more than four times greater than the full 2009 federal allocation for education.