Uncle Sam, Addicted to Debt, Faces Future Military Bills

Washington, DC is going through its annual budget charade. The US Congress is no longer capable of approving individual budgets and appropriations. Instead, a handful of leaders make omnibus deals among themselves and demand the people’s representatives rubber-stamp the result. Otherwise, the government shuts down.

It’s an idiotic way to govern, or, more accurately, to not govern. And the results speak for themselves. Federal outlays are expected to run $6.5 trillion this year. Last year’s deficit — in the absence of a hot war, health pandemic, or financial crisis — ran some $1.7 trillion, the third highest in US history. Interest payments on accumulated debt are forecast to be an incredible $1.1 trillion, about 17 percent of outlays, the highest ever for which data is available. The national debt held by the public (excluding the fake Social Security to Treasury transfer) currently is $27 trillion, more than 100 percent of GDP and climbing.

The latter is almost certain to accelerate in coming years. Interest payments essentially come off the top and, in practice, cannot be cut. Congress would have to either repudiate federal debt or budget responsibly.

The former would solve the problem and prevent its recurrence by stripping Washington of any pretense of creditworthiness. But doing so would impoverish investors and trigger a financial crisis, likely to be seen as at least modest negatives in Washington. Even less practical is reducing annual deficits and accumulated debt, an idea that produces gales of laughter in the nation’s capital. The problem is simple but profound: the Congressional Budget Office figures that in 2034 outlays will run 24.1 percent of GDP, while revenues will be just 17.9 percent of GDP. Balancing the budget requires closing that huge gap. Alas, neither the president nor Congress has the will to make any hard decisions, let alone the slate of hard choices required to avoid fiscal Armageddon.

As the Federal Reserve unwinds its essentially zero interest “quantitative easing” policy, Uncle Sam is now paying higher rates. Moreover, Washington must refinance maturing debt. Explained CBO: “The projected increase in 2024 occurs primarily because the average interest rate that the Treasury pays on its debt is higher this year and is expected to rise further as maturing securities are refinanced at rates that exceed those that prevailed when the securities were issued.” As a result, interest costs are rising faster than any other federal program and have doubled since 2020. This year, interest payments on the debt will exceed the cost of every federal program other than Social Security.

This process will only worsen in the future. Higher interest rates are the new normal and likely to rise further along with borrowing. Noted Lee Ferridge of State Street Global Markets: “All else equal, a bigger government deficit means higher short-term and long-term interest rates.” The growth in interest costs “is equal to about three-quarters of the increase in the deficit from 2024 to 2034,” said CBO Director Phillip Swagel.

Absent spending cuts elsewhere, higher interest costs will force more borrowing, crowding out private investment and slowing economic growth, leading to a higher debt burden. A steadily increasing federal debt also will increase doubts about Washington’s ability to service its obligations, further inflating interest rates. And on it is likely to go.

Washington’s main response has been to understate the problem, publicizing “net interest,” by which interest payments to Uncle Sam are used to reduce reported outlays. Even these cooked numbers cannot hide the problem, showing $1.6 trillion in “net interest” payments by 2034.

In that year, outlays are expected to run more than $10 trillion. Total interest costs will be around $2 trillion, or a fifth of expenditures. The deficit likely will hit around $2.6 trillion. Over the decade, Uncle Sam will run up a cumulative $20 trillion in red ink. The national debt will jump from $28 billion to $48 billion, expected to be about 116 percent of GDP, well above the record of 106 percent set in 1946, as America exited the worst war in human history.

Under more negative deficit assumptions, that Congress preserves expiring tax cuts and relaxes controls over discretionary outlays, the debt could run 131 percent of GDP. Of course, in theory the situation could get better. But the greater long-term pressure will be to increase spending. Demography will inflate Social Security and Medicare expenditures, both of which will nearly double over the coming decade. Health care inflation will drive up Medicaid and other federal health program outlays. The president continues to write off federal educational loans. States and cities face a collective pension deficit of $1.49 trillion and may end up pressing for a federal bail-out. With both Republicans and Democrats supporting a borrow, borrow, spend, spend philosophy, there is little hope for fiscal control in other areas.

To highlight the economic risks, CBO offers a sobering warning about the consequences of escalating debt:

Borrowing costs throughout the economy would rise, reducing private investment and slowing the growth of economic output; Rising interest costs associated with that debt would drive up interest payments to foreign holders of US debt, decreasing the nation’s net international income; … The United States’ fiscal position would be more vulnerable to an increase in interest rates, because the higher debt is, the more an increase in interest rates raises debt-service costs. … All else being equal, an increase in government borrowing reduces the amount of money available to other borrowers, putting upward pressure on interest rates and reducing private investment.

If growth consequently slows, the debt burden will become even tougher to bear. Which in turn could trigger a financial crisis, like that which hit Greece a decade ago. Creditors might come to believe that even the US isn’t able to pay its debts. Financial Times columnist John Plender warned that:

Bond vigilantism is resurgent in the market for sovereign debt. …Could the fiscal disciplinarians of the global investment community now turn their disruptive talents to the US Treasury market? As well as savaging the president of the day, such a challenge could devastate the US’s role as the world’s chief provider of safe assets during global crises, while simultaneously threatening the dollar’s status as the pre-eminent reserve currency.

What to do? One option is higher taxes, but virtually no Republican wants to hike levies on anyone, while Democrats only want to tax “the rich” while the real money is with the middle class. What of the spending side? Legislators tend to concentrate their fire on domestic discretionary outlays, about $1 trillion in annual appropriations for everything from the Washington Monument to congressional salaries. But even wiping out this entire category — which obviously won’t happen — would not balance the budget. And further cuts will come only grudgingly: CBO already assumes virtually no growth in these outlays over the next decade.

The biggest spending boulders are almost politically impregnable. Proposals to cut Social Security and Medicare run into the active and growing block of elders and retirees. Medicaid and other federal health care programs oriented toward poorer Americans are not as popular, but already provide inadequate care to a growing number of recipients. Interest payments can only be cut through responsible fiscal practices elsewhere.

Which leaves military expenditures as the most obvious target. Despite the hysteria which greets proposals to reduce military outlays, they are not equivalent to “defense” spending. Much of the money goes to war-fighting equipment, but few of those conflicts have much to do with protecting America. Last year Congress passed a record $858 billion Pentagon spending bill. This number didn’t include some important national defense expenditures, like those for nuclear programs, which lie within the Department of Energy, and veterans’ health care.

The US spends far more than its chief antagonists. The disparity grows vastly larger when outlays by Washington’s allies in Asia, Europe, and the Middle East are added. America is the most secure great power ever, with oceans east and west and peaceful neighbors north and south. Why do Americans spend so much to defend allies who spend so little?

After all, Russia has yet to best Ukraine while studiously avoiding war with the US. The Europeans already spend more than Moscow on defense and are more than capable of containing the latter. China suffers from multiple weaknesses and does not threaten America militarily. Instead, Washington is attempting to impose its will on Beijing near its border thousands of miles away. Better for friendly states in the region, led by Japan, to copy China’s anti-access/area denial strategy for their own defense. Iran and North Korea would face destruction if they attacked America and can be contained by their neighbors.

Defense is the federal government’s most essential responsibility. But that means protecting the American people — their lives, liberties, constitutional system, and territory. Alliances should be a means to an end and, as George Washington famously warned, should not turn into permanent attachments: “nothing is more essential than that permanent, inveterate antipathies against particular nations, and passionate attachments for others, should be excluded.”

Red ink will accumulate at an accelerating rate. When the inevitable crisis hits, it will be even more difficult to reach a rational solution. Better to start now with the misnamed Defense Department. Washington should focus on genuine defense. The US can no longer afford to treat the Pentagon as a welfare agency for the influential and well-connected abroad.

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