(Bloomberg Opinion) -- President Joe Biden hopes to spend $4.1 trillion on infrastructure, education and various social programs, efforts we think are worthwhile. We believe it’s a necessary investment in physical and intellectual capital that will make the U.S. more competitive, and Americans more prosperous, in the decades ahead, as we argued in a column on Wednesday.
Now the question is how to pay for it. The administration wants to finance it by raising taxes on companies and high-earners. But with long-term U.S. interest rates at historic lows, a record surge of cash in circulation and many Americans flush with savings accumulated during the pandemic, the federal government also has access to a trove of cheap money. Given that unusual opportunity, and the opposition higher taxes are likely to generate among some moderate Democrats and many Republicans, we think Congress should primarily borrow the money needed for Biden’s plans.
Many Americans reflexively oppose the idea of adding to the national debt. In a Pew Research Center survey last June, about half of U.S. adults said that federal budget deficits are a “very big problem,” with older Americans almost twice as likely to hold that view as younger ones. While people tend to become more conservative with age (particularly about money), relentless drumbeats about the dangers of government debt are probably also at work.
There’s no shortage of deficit hawks warning about the calamities of government debt (some of whom have forgotten that their patron saint of lean government, Ronald Reagan, ran up huge deficits). Members of Congress routinely rail against deficits. The National Debt Clock, a billboard-sized digital tally of U.S. debt on display in New York City, and knockoffs around the country, mindlessly tick higher without bothering to explain why more debt is necessarily bad. Even President Biden joined the act last week, telling reporters he’s “not willing to deficit spend.”
Why not? Deficit hawks fear that adding to the national debt will stoke inflation, push interest rates higher and divert investment from the private sector. There’s little indication from markets or the economy, however, that adding $4 trillion to a $28 trillion debt load would be problematic, or that policy makers lack the tools to manage unwanted side effects.
Let’s start with inflation. Economists and policy makers are haunted by the 1970s, a decade in which persistently rising inflation bedeviled the economy, topping out at around 15% in mid-1980. No one wants a repeat of that episode, but the experience also showed that inflation can be tamed. After Paul Volcker, the chairman of the Federal Reserve at the time, decided to raise short-term interest rates meaningfully higher than the inflation rate -- a level that lifted nominal rates to as high as 20% and inflation-adjusted rates to 10% in 1981 -- inflation dropped to around 2.5% by 1983.
Granted, slaying inflation came at a cost. The Fed’s drastic rate increase hammered the economy, triggering a pair of recessions in the early 1980s. But an intervention of that magnitude is unlikely to be needed again. Last time, the Fed waited too long to intervene. Inflation began to nudge uncomfortably higher in the 1960s and kept rising for several years before the Fed stepped in. Its initial attempts to tamp down inflation also didn’t go far enough. While the Fed raised short-term interest rates several times during the 1970s, real rates remained negative for most of the decade, which further fed inflation.
On Wednesday, the Labor Department reported that year-over-year inflation grew to 4.2% in April, the most since 2008 and well above the Fed’s long-term inflation target of 2%. Fed officials expected a temporary spike in inflation as the economy recovers from the pandemic. That data is also noisy, with some of the biggest jumps in Covid-battered sectors such as transportation and hotels. Fed Chair Jerome Powell has repeatedly said he believes that core inflation growth is still manageable. If inflation continues to rise, the Fed can move quickly to raise real rates to fend off a replay of the 1970s.
There’s also no reason to believe that more debt will necessarily push interest rates higher. Historically, there’s been no meaningful correlation between the national debt as a percentage of GDP and the level of interest rates. The debt-to-GDP ratio has more than quadrupled since 1980, yet interest rates have declined steadily. That jibes with Japan’s recent experience. Its debt-to-GDP ratio has quintupled since the early 1990s, and yet interest rates have plummeted.
In theory, adding to the national debt might cause investors to sour on Treasuries. The resulting decline in demand could push interest rates higher, forcing the government to pay higher interest and handing losses to bond investors. But as of now, all signs point to continuing downward pressure on interest rates.
Treasuries are still among the safest and highest yielding bonds in the developed world, so they continue to be in demand. A modest uptick in the U.S. debt-to-GDP ratio isn’t likely to change that. Adding $4 trillion to the national debt would raise the debt-to-GDP ratio to about 1.5 from 1.3, assuming total debt of roughly $32 trillion and GDP of $22 trillion this year.
For perspective, Japan’s debt-to-GDP ratio hovers around 2, and it has little trouble issuing debt at rates well below those in the U.S. And if interest rates move modestly higher in the U.S., the government should still have little trouble servicing its debt, even after accounting for an additional $4 trillion in borrowing. Interest as a percentage of GDP was just 1.6% last year, half of what it was in the early 1990s.
There’s also no indication that government spending is interfering with companies’ ability to borrow. The U.S. has added about $5 trillion to the national debt since 2020, and yet companies are borrowing briskly and at the lowest rates in 100 years. In fact, some economists and observers are concerned that it’s too easy to borrow and that low rates keep weak companies on life support.
Corporate America is taking full advantage of low rates whether it needs the money or not — a move the government can learn from. Apple Inc. has added about $15 billion to its long-term debt since 2019, despite already being indebted and cash rich. Amazon.com Inc. has more than tripled its long-term debt to $85 billion since 2018, even as it sits on $34 billion in cash. There are numerous other examples. Politicians often point to the private sector as a model of savvy efficiency that the government should emulate. We agree.
Excessive government debt would be a problem, of course, but nothing points toward excess right now. Critics who are averse to government debt are conveniently forgetting how central well-managed debt is to American life and wealth creation. Families routinely borrow to buy homes. Small businesses routinely borrow to expand their operations. Large companies routinely borrow to pay for research and development. Sophisticated money managers routinely borrow to enhance their returns. The common denominator in all of those examples is the core belief that borrowing to invest wisely now will pay off later. Shrewd public finance is built on the same principle.
Relying on debt to finance Biden’s agenda doesn’t necessarily mean tax rates should stay where they are. Rates have been inequitable for decades and have contributed to growing wealth and income inequality. The huge tax cut Republicans engineered during the Trump years further widened the gap. All of that needs to be addressed. But the Biden administration will be in better negotiating and financial positions wielding the power of debt, rather than relying solely on big — and politically toxic — tax rate increases.
So go ahead, Biden — borrow.
This is the second of two related columns. You can read the first one here.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.
Timothy L. O'Brien is a senior columnist for Bloomberg Opinion.
©2021 Bloomberg L.P.
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