This quote is from Chuck Prince, CEO of Citigroup, in July 2007, on why the bank loosened housing lending standards and created ever more complex derivative securities. They had to keep up with the competition. And we all know how this ended – the Housing Bubble and Great Recession of 2007-2009.
Today, are we “whistling past the graveyard” again, this time with respect to government debt? Washington argues that to restart the economy we need increased spending, and deficits be damned. This was the same argument made after the Great Recession in 2009. We increased spending, but we did not increase taxes for fear of further damage to the economy. Same playbook today.
During WW II, debt rose to pay for the war but then declined as a percentage of GDP as the economy expanded in the 1950s (see chart below). Now debt as a percentage of GDP is closing in on the all-time high of 106%. It is forecast to be 114% next year.
The Federal Reserve is building an ever-increasing amount of debt today. It now owns nearly 20% of all outstanding Treasury securities. To pay for these it is pumping reserves into the banking system, which can be inflationary. So far this has not led to higher interest rates and, only recently, to higher prices.
There seems to be no appetite in Washington today to change the current strategy of “increase spending with as little tax pain as possible.” Historically, Republicans have been the fiscal conservatives, but the national debt increased by $8 trillion during the Trump administration. So, the barn doors are now open to further deficits and debt increases.
To be fair, a vibrant and growing economy can handle an increase in debt just as individuals can handle a bigger mortgage when incomes rise. So an increase in the national debt is, in and of itself, no reason for panic. Still, if interest rates rise from here the cost to service the debt will go up. Combine this with increased spending for social programs and defense and a very divided Congress unable or unwilling to work together, and you have the potential for real trouble.
