Monday, August 24, 2009

Financing the Deficit

At the Scratching Post, KT has some nice graphics showing the mushrooming debt under Obama. Unfortunately, it also shows that the Bush administration, while not nearLY as bad, still did us no favors. Bush inherited a surplus and turned it quickly into deficit.

KT also has some comment on the impact of the manner of financing the national debt, as in short term (think ARM) versus long term (think 30 year fixed). I used to not worry one way or the other, but with the deficits increasing without end, we will either get big increases in inflation, or a severe tightening by the Fed, or both. The end result will be huge increases in short term interest rates.

I have liberated the rest of my commentary on KT's post.

All other things being equal, ARM funding is usually less expensive than long term debt (even in the long term), but it exposes the borrower to more risk. It is a classic trade off between risk and benefit. The federal government theoretically could manage its own risk in this regard as it has the power to keep inflation under control. From one perspective more short term debt is a rational outcome.

However, government is run by politicians not accountants or economists. The actual effect of the ARM financing has been to minimize the impact of the debt on the federal cash flow, thus encouraging larger deficits. As a result, we are doubling down on the risk, because high deficits lead to higher inflation risk, which in turn lead to higher risk that debt servicing will become unsustainable.

I think the bigger question is how long will it take for these monster deficits to work their way through the whole economy and re-ignite inflation. Hopefully in time to influence the 2010 elections, so that voters can feel the true consequences of stimulus and vote accordingly and perhaps put the brakes on these huge deficits. Unfortunately, the Republican party has yet to adequately re-brand itself in image and in fact as a party of smaller government and reform, so they may not reap the benefit of inflation turning the Obama presidency into Carter II.

1 comment:

  1. Thanks for all the links! I frequently grab comments and grow them into posts as well. Why let a good thought go to waste?


    As for the ARM financing, I'd suggest that has an easy answer. Politicians want to maximize votes for themselves. Now that our society no longer treasures earning what you get, there is no bonus for fiscal prudence. It's all about giving away goodies. The ARM financing extends the time they can give away goodies for free before the whole thing collapses.