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HomeMarketA Debt-Ceiling Fight Could Raise U.S. Borrowing Costs and Worsen Budget Deficits

A Debt-Ceiling Fight Could Raise U.S. Borrowing Costs and Worsen Budget Deficits

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About the authors: Arvind Krishnamurthy is the John S. Osterweis professor of finance at the Stanford Graduate School of Business. Hanno Lustig is the school’s Mizuho Financial Group professor of finance. Both are senior fellows at the Stanford Institute for Economic Policy Research.

The last time the U.S. government posted a budget surplus, Michael Jordan was still playing in the National Basketball Association. That was 2001, the first year of George W. Bush’s presidency. Since then, the federal government has been running ever larger deficits. And there is no fiscal relief in sight. The nonpartisan Congressional Budget Office projects that federal deficits will average 3.5% of gross domestic product over the next three decades—not accounting for interest payments. Including interest, deficits are projected to average 7.9% of GDP by 2052, pushing the ratio of debt to GDP up to 195%.

When the CBO makes these spending and tax revenue projections, it assumes that current laws will remain in place. But deficits eventually will have to be paid down. What the CBO projections really tell us is that eventually Congress will have to change existing tax and spending plans. Given the size of the adjustment needed, it isn’t realistic to think that big-ticket items such as Social Security, Medicare, and the military can be taken off the table. And tax increases should be considered as well. That is the fiscal reality.

Economists like to say there’s no such thing as a free lunch. But when it comes to fiscal arithmetic, U.S. taxpayers haven’t had to settle the bill. The U.S. Treasury has been able to borrow at especially low rates because it is the provider of the world’s safe assets—that is, the dollar is the world’s reserve currency. Investors around the globe use Treasuries as foreign-exchange reserves and as the collateral that ensures the smooth working of international financial markets. Treasuries are the benchmark against which other securities are measured. We estimate that this is worth up to 1% annually in lower costs of borrowing. In other words, the U.S. government’s borrowing rates would be 1% higher in a world where the dollar wasn’t the reserve currency.

This free lunch has allowed the Treasury to sustain larger deficits, and for longer, than other countries. But even so, the numbers don’t add up: A 3.5% primary deficit is too large to be sustained indefinitely. Spending and taxes will have to adjust.

Clearly, the federal budget process isn’t working properly right now. The U.S. government hit its statutory limit for debt in January. House Republicans say they won’t raise the limit without overall spending cuts. Is threatening a default by not raising the debt ceiling the right way for Congress to kick-start the inevitable fiscal adjustment? Not unless we want to deny future generations the fiscal free lunch we have enjoyed for the past few decades. If the federal government defaults, global investors may start to look for alternatives to Treasuries as safe assets. That would make deficit projections even worse by increasing the cost of borrowing.

For now, financial markets don’t seem concerned about this scenario. Treasuries are still perceived to be safe, a necessary condition for the dollar to be the world’s reserve currency. The debt-ceiling showdown in 2011 caused only a minor dislocation in the Treasury market. But the fiscal situation today is far more fragile. We have more than twice as much debt outstanding: $31 trillion, compared with $14 trillion in 2011. The Treasury has to roll over 30% of that debt, more than $9 trillion, over the next 12 months. If investors become nervous about the Treasury’s ability to do so, the resulting volatility could undercut the appeal of Treasuries as safe assets. And the Fed’s ability to intervene in Treasury markets, as it did in March 2020, is now limited by its commitment to shrinking its balance sheet in the face of persistent inflation.

Paradoxically, the bond market’s insouciance may contribute to more brinkmanship on Capitol Hill. If Congress starts a fiscal correction only when the bond market begins to price in fiscal risk, but investors continue to price Treasuries as perfectly safe, it creates political incentives for more fiscal recklessness on both sides of this debate. Instead, Congress should get to work by lifting the debt ceiling and then putting the federal budget back on a sustainable path—hopefully before LeBron James retires from the NBA.

Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to


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