Tags: ffr | volcker | rates

Fed Tightening Could Explode Nation's Debt

Fed Tightening Could Explode Nation's Debt
(Dmitrii Melnikov/Dreamstime.com)

Jefferson Weaver By Wednesday, 11 January 2023 03:52 PM EST Current | Bio | Archive

In 2022 the Federal Reserve ended a decade-long policy of historically-low interest rates with a series of unprecedented increases in the federal funds rate (FFR) — which sets the interest rate banks charge each other for overnight loans.

But everything is relative and even though the year 2022 saw four successive FFR increases of 0.75% followed by a year-end kick in the teeth of another 0.50%, it represented nothing more than the FFR returning to its long-term historical average of around 4.5%.

After all, the Fed had held the rates near 0.0% since the Great Recession of 2008 and, following some minor upward adjustments, had once again pushed the rates back toward 0.0% to stimulate economic activity during the COVID-19 pandemic.

There have been greater disruptions in the debt markets, the most famous of which occurred in the late 1970s and early 1980s when the Federal Reserve, under the guidance of then-Chairman Paul Volcker, acted to strangle the inflationary spiral roiling the country at that time.

Indeed, the year 1981 started with the FFR at 22.0%, a staggering rate that one would expect to find more commonly charged by loan sharks and credit card companies (though the line can sometimes be blurred between the two).

But Volcker decided that the danger posed by possible hyperinflation far outweighed the costs of pushing the nation into a recession.

So he oversaw a series of rapid increases in the FFR until the rate of inflation moderated; thereafter, the Federal Reserve dropped the FFR over the next three years until it was less than 9% in 1985.

Because the Federal Reserve maintained an abnormally low FFR for the past decade, it reduced the borrowing costs for individuals and companies alike and also facilitated the movement of hundreds of billions of dollars into both traditional assets such as real estate and stocks as well as more speculative investments such as cryptocurrencies — thereby pumping up values to unprecedented (and, in many cases, unsustainable) levels.

On the other hand, near-zero interest rates punished savers who found that they could not get more than a fraction of a percent of interest on their certificates of deposits or savings accounts.

Another lingering effect of the ultra-low interest rates was that it caused many policymakers to be less concerned about deficit spending because the cost of financing government debt was viewed as almost non-existent.

According to Investopedia.com, this view was encompassed in a macroeconomic theory called modern monetary theory whose advocates argue that sovereign states can ignore fiscal constraints when they spend, tax, and borrow using their own fiat currencies. In short, it embraces the view that the specter of ever-increasing debt can be kicked down the road forever.

Those of us who try to balance our checkbooks at least once a year or so are less sanguine about this approach as it seems to be nothing more than an invitation to governments to ignore any type of budgetary discipline.

A recent report issued by the Peter G. Peterson Foundation noted that the increases in the FFR in 2022 could have devastating long-term effects (notwithstanding the carefree optimism offered by the modern monetary theorists who probably do not balance their checkbooks at all) because the FFR is the benchmark for U.S. Treasury securities.

The interest on these securities will almost invariably rise, which will cause the government's borrowing costs to explode.

The report noted that the Congressional Budget Office (CBO) had projected the nation's annual net interest costs would total $399 billion in 2022 and nearly triple to $1.2 trillion in the ensuring decade.

Even more ominous is that these interest payments would total around $66 trillion over the next three decades and suck up nearly 40% of all federal revenues by 2052. Indeed, interest payments on the debt could become a massive budgetary black hole that would, according to the Peterson Foundation, surpass defense spending in 2029, Medicare in 2046 and Social Security in 2049.

Put another way, the interest costs in 2052 are projected by the CBO to be nearly three times the amount the government has historically spent on research and development, infrastructure, and education combined. Chairman Volcker did not have to worry as much about the budgetary consequences of dramatic rate hikes because the national debt did not total $1 trillion until 1981 — less than a thirtieth of today's amount.

The yawning pit of government debt threatens the long-term viability of the nation. 

Unfortunately, the solution rests with the same political establishment that has avoided making the hard choices for decades as to how much butter and guns the nation can afford. 

However, the swelling ocean of red ink may soon force gut-wrenching decisions that could threaten our very way of life.

Jefferson Hane Weaver is a transactional lawyer residing in Florida. He received his undergraduate degree in Economics and Political Science from the University of North Carolina and his J.D. and Ph.D. in International Relations from Columbia University. Dr. Weaver is the author of numerous books on varied compelling subjects. Read more of his reports — Here.

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The yawning pit of government debt threatens the long-term viability of the nation. Unfortunately, the solution rests with the same political establishment that has avoided making hard choices for decades.
ffr, volcker, rates
Wednesday, 11 January 2023 03:52 PM
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