As the federal budget deficit rises, so do the risks

Do we have our head in the sand when it comes to deficits?Andrey Kuzmin, stock.adobe.com/Adobe

Republicans and Democrats seem to have finally found something they agree on: Deficits are no big deal.

On Wednesday, Senate leaders from both parties reached a preliminary bipartisan agreement to increase spending by as much as $500 billion over several years — enough to drive the federal budget deficit above the $1 trillion threshold in 2019, according to an estimate from the Committee for a Responsible Federal Budget.

There has been some grousing from House Republicans in the right-wing Freedom Caucus — including Arizona Representative Paul Gosar, who carped: “There’s no way in hell I sit by and vote for this.”

And it’s still possible they’ll try to block this spending deal.

But in December, Gosar and the entire Freedom Caucus voted for the Republican tax plan, which is expected to add nearly $1.5 trillion to the deficit over 10 years.

Just because the debate over deficits has grown stale and is marred by bad-faith arguments doesn’t mean rising deficits are benign. They carry real risks for the government, for the ongoing whiplash on Wall Street, and for the health of the entire US economy.

Here are six of the biggest concerns, listed in order from mild to truly menacing:

A deficit is like an IOU

Eventually it has to be paid back. So every time government deficits rise, so too does the uncertainty about how exactly the money will be repaid.

And there is no magic solution, just a choice between raising taxes (eventually), cutting programs (someday), or finding a workable balance betweenthe two.

The fact that states, businesses, and individuals don’t know the outcome makes it harder to plan for the future, because they can’t tell if we’re headed toward a high-tax or a low-service world.

And the whole situation is made more vexing by the D.C. seesaw, with power oscillating between two polarized parties with totally different preferences.

A deficit is more like an IOU atop a pile of existing IOUs

Namely, that’s the $15 trillion in government debt. Not only do rising deficits add to the pile; they actually make the whole debt load harder to finance. That’s because in the short term, deficits are paid for with government borrowing in the form of Treasury bonds. With rising deficits, the government needs to sell more bonds, and when the economy is strong — as ours is — the only way to attract additional investors is by raising the payouts (i.e., the annual yields). But guess what? Those new, higher yields feed back into the old debt, making it more expensive to roll over or refinance.

Something similar happens to companies

They also issue bonds.

When trillion-dollar deficits force the government to attract new investors with higher bond yields, guess who also has to raise payouts to keep up?

Corporations.

Even small increases in bond yields would make it harder for companies to attract capital, blunting investment.

But big jumps in the bond market could leave some businesses underwater, unable to cover their existing debts and short on the cash needed for daily operations.

Stocks: another risk

Our already-wobbling stock market — the Dow fell more than 1,000 points Thursday — is another potential victim of government deficits.

Because if bond yields do rise as a result of increased government borrowing, investors will take note, shifting more of their money out of stocks and into corporate or government bonds.

After all, who needs the risk and volatility that come with investing in stocks when you can get decent-paying, generally stable returns on bonds?

Should that shift actually occur, it would drain demand from the stock market and push share prices even lower.

Investors may start avoiding government bonds

At some point, they may start refusing to buy government bonds altogether, out of concern that the United States will never cover its debts.

That would trigger a full-blown debt crisis, leaving the government unable to finance its operations.

The mere fact that the United States has its own currency makes this less likely, because we can always print dollars as needed.

But if a debt crisis did erupt, it could destabilize the entire economy, driving up interest rates while forcing the government to rapidly reduce deficits with either massive tax increases or sudden spending cuts.

What about the next recession?

Among all the risks that come with rising government deficits, the one that seems most urgent is lack of readiness for the next recession.

When the last recession hit, we fought back on two fronts: The Federal Reserve cut interest rates by 5 percentage points to encourage borrowing, and Congress passed an $800 billion stimulus package to boost overall spending.

Both tricks will be a lot harder to pull off next time, since interest rates aren’t high enough to allow for a 5 percent cut, while large-scale stimulus could push the deficit to truly unprecedented levels. We are, as a consequence, much more economically vulnerable.

So much for the blasé attitude toward deficits. But if reading through this list has you sweating, the good news is these fears may still be overblown; the United States has been running regular deficits for 15 years, with little impact thus far. Still, it might be nice if more D.C. lawmakers were taking such concerns seriously.