10
Mar
11

It’s the debt-service payments, stupid

I became a short-term deficit hawk a couple years ago, to the shocked dismay of most of my acquaintances who knew what “deficit hawk” meant.  Most of them were and are — and I mean this with affection if you’re one of ’em and reading this — pragmatically innumerate, such that when I say “we need to stop spending so much damn money on wide-scale corporate income supports and every damn social programme that gets half a vote” they call me a stone-hearted fascist.  Most of the rest are neo-Keynesians, which means the same thing except they’re more likely to brush off my concerns with “in the long run, we’re all dead“.

Now, a lot of people have become deficit hawks out of rising alarm at pretty scary things, like demographic change (“zOMG all the Boomers are retiring and the labour force is shrinking!”) or pension commitments coming due (“zOMG all the Boomers are retiring and the stocks we thought would return 12% per year are in the shitter!”) or especially health-care costs (“zOMG all the Boomers are retiring and &c.“).  Those who’ve been paying attention to the CBO’s projections of future costs are most vitally concerned about Medicare costs, and I find it hard to blame them.  But that’s not what concerns me most, and I’m gonna tell you why.

We tend to think about even government debt in household terms: debt is something you’re obliged to pay off.  No-one — though the last four years have convinced me that I may be wildly optimistic on this note — takes on a mortgage with the mindset that “I’m going to pay $700 a month interest on this principal for the rest of my life, and then my kids will take it over”: we at least intend to pay off the principal of any loan we take on, even if we’ve been sold a bill of goods by some shyster looking for another shitty loan to sell to Fannie Mae.  But government debt doesn’t work that way, and it doesn’t work that way on a fundamental level: it’s an investment rather than a contract.  If I buy federal bonds, it’s not because I want my principal back: it’s because I want the interest on my principal over the term of the loan, and as long as I believe the government can keep up on the interest payments I’m not going to let it pay off the principal.  As much as some of us loathe government debt, we’d probably be pretty fucking annoyed if thuh feds told our pension planners’ money-market funds “Okay, here’s your principal back; we’re through”.

The key point here is that it doesn’t really matter how much debt a government holds, in absolute terms.  What matters is how well the government can service that debt by paying interest to bondholders and &c.

So here’s the problem: as government spending commitments grow ahead of government tax receipts, so do government debt-service payments.  And once those debt-service payments get too big, bond markets get scared that the government in question ain’t a-gonna be able to hold to its commitments.  That means higher risk, and with higher risk comes higher interest payments… and welcome to the Weimar Republic flavour of the positive feedback loop.

Now, look at this chart of projected US government expenditures:

Source: The Incidental Economist
y-axis is %GDP

Who do you think is going to buy Treasury bonds in 2040?  No-one, that’s fucking who!

Austin Frakt’s gloomily-accurate analysis continues thus:

Meanwhile, if future government revenue is no higher than it has ever been in the past, relative to GDP (~19%), we already cannot afford the government we have, let alone the interest payments on it.

But don’t worry; it won’t take ’til 2040.  The bond markets are already well aware of how fucked we are:

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits.

In other words, interest rates need to go up for the bond markets to stay interested in buying US government debt.  Who’s been buying US government debt in the mean time?  The Fed, of course; it’s called quantitative easing, and it’s a “stimulus” programme.  Lookit that stimulus:

Source: Andrew Sullivan

Oh yeah, we’re gonna grow our way out of debt any day now!

My point here is that, contra the “deficits don’t matter” fucknozzles we’ve had “governing” our countries for the last few decades, deficits do matter, and they matter in the most fucking immediate short term — and yes, Boomers, that means before you die and pass on your problems to your children.  The scope of the problem — which we’ve all been ignoring for thirty-odd years — is now such that a few inconvenient but largely painless nips and tucks here and there will no longer suffice to curtail the damage.  Yes, we’re gonna need to raise taxes (and yes, that’s going to slow recovery even further).  Yes, we’re gonna need to scale back safety-net programmes (and yes, that’s going to slow recovery even further).

But the really bad news is that the longer we ignore the problem — and I’m not such a Pollyanna that I suspect we’re going to raise taxes and slash benefits right away — the worse we make it, and the more severe our tax hikes and programme cuts are going to have to be in the future, because those debt-service payments are just getting bigger every quarter.

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9 Responses to “It’s the debt-service payments, stupid”


  1. 1 perlhaqr
    March 28, 2011 at 09:03

    Ok, maybe this is a stupid question, but I’m still having difficulty transitioning from my personal “Holy fuck I hate being in debt kill the principle now!” position to one where “steady state principle owed is somehow a good thing”.

    If we stopped increasing the debt, would the debt service payments remain constant? Presuming interest rates didn’t go up, I guess, since these things probably roll over.

    Though, honestly… I don’t know if I care that it would annoy people if the FedGov said “here’s the principle back, we’ve decided to not be in debt any more”. I would rather the taxes collected go to providing services and buying infrastructure, if they have to be collected at all, rather than paying interest to people who just happen to have some paper.

    • March 28, 2011 at 13:13

      I guess it comes down to creditor trust, and that’s reflected in the structure of the investments. You should definitely double-check this because I’m not at all an expert in the bond market, but my understanding is that bonds are designed such that the borrower (the Treasury) only pays interest on the bond, and only actually repays the principal in extraordinary circumstances. Debt’s expected to be rolled over constantly, because the creditors trust the government to be able to pay off the principal in one go if and when they’re called on it.

      Contrast this to, say, a 30-year fixed-rate mortgage. There’s no way any bank would expect you to make fixed interest payments every month, like clockwork, for thirty years… then suddenly pay off all the principal at once. The term of the loan is so long because you’re paying off the principal one small chunk at a time.

      This is why Treasury bonds are (for the nonce) a very safe (as in predictable) investment and mortgages, as we’ve seen, aren’t. But bonds are only good if the bond market thinks the borrowing government is going to be able to repay or renew them (see, for a counterexample, Greece).

      It’s not so much that steady-state principal with more-or-less constant interest payments is a good thing, but it does make for a pretty good investment from the perspective of the creditor and it’s a completely different beast from a typical personal loan.

      I would rather the taxes collected go to providing services and buying infrastructure, if they have to be collected at all, rather than paying interest to people who just happen to have some paper.

      How ’bout we do it the other way around? Rather than set up service-and-infrastructure programmes that claim a big chunk of tax revenue in perpetuity, we make the gov’t issue debt every time it wants to build a new aircraft carrier or interstate, and insist that tax revenue can only be spent on debt service. Whoever holds the debt — pension funds, hospitals, municipal public-works departments, etc — can decide for themselves how to spend money on services-and-infrastructure (or hookers and blow) rather than have those programmes run from DC. It basically turns the FedGov into a very, very boring sort of investment bank. (I’m morally certain that I’m not the first to come up with this idea.)

      • 3 perlhaqr
        March 28, 2011 at 17:00

        There’s no way any bank would expect you to make fixed interest payments every month, like clockwork, for thirty years… then suddenly pay off all the principal at once.

        That’s not entirely true, even before the recent mortgage market fuckup, and certainly not true during it. I was looking into some property a long while back, and what was being offered was a “balloon payment” mortgage. It’s basically a 30 year mortgage rate and payments, but you have to suddenly pay it off at the 5 year mark.

        And of course, banks were doing all sorts of stupid shit during the mortgage frenzy, interest only mortgages, negative interest mortgages, where your principal actually went up every month…

        But I always thought all that crap was crazy, too. I didn’t even have credit cards until a few years after college, which I also got through debt free… so, yeah, I might be a bit odd on the subject of being in debt. I have a mortgage and my wife’s student loans and a car payment, and believe me, it hangs over me.

        How ’bout we do it the other way around? […] It basically turns the FedGov into a very, very boring sort of investment bank.

        I… I dunno.

        Frankly, well… I’m an anarchist of the “took American libertarianism too far” stripe. It’s really hard for me to think on questions like “how would you like the FedGov to do X”, since, ultimately, I’d prefer they weren’t doing it at all.

        I fully admit this is a failing on my part. :)

        Is your idea that the people who were buying the debt could choose what sorts of things they were helping finance?

        I’m not sure that gives the sort of incentives I’m looking for, really. I want incentives for people who want programs to get stuck paying for them, and leave me out of it if possible.

        • March 28, 2011 at 17:17

          First of all, thanks for bringing intelligent debate to my comments section. :-)

          You have some good counterexamples on the silly-mortgage front (which I was trying to dodge around with my “30-year fixed-rate” stipulation). I think they support the point I was trying to make but failing to articulate, though: mortgages are based on the idea that the borrower is ultimately untrustworthy, or at least ultimately unpredictable, whereas government bonds are predicated on the idea that the borrower is ultimately trustworthy. The silly mortgages you mention were designed to game the secondary market incentives (although Wikipedia claims that balloon-payment mortgages are generally targeted at the commercial sector, so bankruptcy law incentives might come in there too). I can’t for the life of me figure out how the issuing banks convinced the ratings agencies — or the investment banks, for that matter — that shit like negative-interest mortgages were anywhere near investment-grade.

          As for the issue-bonds/tax-for-interest model, yeah, it’s just a half-baked thought experiment. The idea is that it puts “government tax income” closer to the people who’ll ultimately do stuff with it (like build roads and run schools). The possibility of a government not being able to raise money for an unpopular project — if no-one will buy their debt — hadn’t occurred to me, but it’s an interesting idea. Maybe they’d have to raise interest rates on that particular run of debt to convince people to buy it, which is a weird way of backing into market-based governance. I haven’t thought through the incentives at all.

          I don’t know if I’ve made this sufficiently visible, but I’m an anarchocapitalist in roughly the Claire Wolfe/L. Neil Smith sense as time t goes to infinity, and a deficit hawk short-term.

          • 5 perlhaqr
            March 28, 2011 at 18:28

            Sure, glad to do so. In case it’s not obvious, I got here via the recent postings in the ‘Nerds blog.

            I think they support the point I was trying to make but failing to articulate, though: mortgages are based on the idea that the borrower is ultimately untrustworthy

            That’s an excellent point. A borrower you know will pay you back only needs to pay for the time displacement of your capital, whereas a borrower you’re not sure about needs to pay for the time displacement and the risk factor. Which, as you mention, is factored according to other market distortions like bankruptcy law.

            And yeah, now that you mention it, it was a commercial property I was looking at. (I’m a car mod nerd. I run into zoning law pretty frequently. I need a place I can tear things apart, and tell the city to bugger off about it.)

            The possibility of a government not being able to raise money for an unpopular project — if no-one will buy their debt — hadn’t occurred to me, but it’s an interesting idea.

            It’s at least a lot closer to the sort of incentive I’d like to see. I may still have to help pay it back over 30 years at gunpoint, but the people who really want it have to give up all the cash for that new missile system now.

            I don’t know if I’ve made this sufficiently visible, but I’m an anarchocapitalist in roughly the Claire Wolfe/L. Neil Smith sense as time t goes to infinity, and a deficit hawk short-term.

            This is roughly correspondent to my position. I’ve recently started describing my market-anarchist philosophy as a religion, because I think that gives a better frame of reference to a lot of people. Christians speak of the ideal of living a “Christ-like life”, with the understanding that humans are imperfect and realistically, only the son of God can pull this perfection shit off. Well, I think of Anarchism as sort of the perfect ideal; the standard to advocate for. But on a more practical level, I understand that it’s going to take a good long while to get there (if ever). So I’m a deficit hawk, too. I think it would be safe to call me a deficit hawk with a side of wanting to reduce the overall debt, in fact. And while I’m wishing for a pony, I’d like to see a general reduction in the regulatory state, so the old American culture of Getting Shit Done could stop being so choked off.

            It’s genuinely hard to start a new business. Not only will the bastards try to choke you with confiscatory tax rates, they won’t even let you try to be productive enough to confiscate from.


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