Is There Any Interest?
Written in 2004
How do interest rates affect the debt and the deficit?
The short answer is: profoundly. The National Debt has a huge impact on interest rates. And interest rates have a huge impact on the deficit, hence on the debt.
Interest is third largest item in the budget.
In many recent years we spent more money on interest than on any other federal expense. (Social Security payments are much larger, but of course they are paid out of funds built especially for that purpose, rather than from general funds.) In many recent years prior to the Iraq war, even the entire defense budget was not as large as expenditure on the debt. Spending on health and human services has even been less than interest on the debt in some years.
If we didn't have to pay all that interest, we wouldn't have a deficit at all. In 1992, interest on the debt accounted for virtually the entire deficit. In that year we would have had a balanced budget, if we had paid no interest. In every year since then, until the Iraq war, we would have had a surplus, if we hadn't had to pay the interest. In 1997, that surplus would have been over $330 billion. But of course there was no surplus in 1997; we paid over a third of a trillion dollars in interest, and went deeper in debt by $22 billion. Only in the year 2000 did we finally have a small surplus. But now, because of tax cuts and major spending increases, we are back in the businesses of bigger deficits and growing debt.
Instead of paying off some of the National Debt in the past dozen years, we have gone much further into debt. Since the year 2000, the debt has grown by nearly a fourth. That is almost entirely due to the interest we must pay to service the debt.
The US Government is the biggest borrower in the market.
Every year, the Federal Government must pay back about a third of the total amount of the National Debt. In addition to that, in most years, it has had to finance the entire deficit. Of course there isn't a reserve available to pay those expenses, so we must borrow. The amount we borrow is immense. It's about 25% of the entire Gross Domestic Product of the nation.
We've been extremely lucky in the nineties, and in the twenty-first century. Business has been good. The money supply has been good. Inflation has been low, so the Federal Board has been able to keep interest rates low. Borrowing has been cheap. The government has been able to borrow a lot of the money it needed at 6% interest or less. That is the main reason our deficits fell during some of these years.
Interest conditions are still pretty good, though not quite as good as in some of the early years of the nineties. We're now paying about 6.5% for the money the government borrows. There are a lot of reasons for that, but one of them is simply the amount we have to borrow. The loan market is an auction market. When the demand for money is high, lenders can charge higher interest rates. Because our government borrows as much as it does, it is the maker of the auction market. If the availability of investment funds drops, the government must assure that it attracts enough of those funds to meet its needs. The only way it can attract that money is through the interest it pays.
It's simple. The more we have to borrow, the more we have to pay for it. And our need to borrow has skyrocketed since 1980.
It's a trap!
It's a trap, and we're caught in it, to the tune of $277 per month for the average working person. That's your share of the interest on the National Debt. And you're paying it. Right now. Do you have two working people in your household? Then you're paying twice that much.
The only way out of the trap is to eliminate deficits and then use surpluses to pay down a significant amount of the debt. We must do it. If we don't, we'll eventually pay much higher interest rates than we're paying now. Then the deficit will rise even faster. And the debt will grow even faster. That is a spiral that could cause the collapse of our entire economy. The last time the interest rate spiral happened to us in the late seventies and early eighties, it was devastating. But now the numbers are much greater than they were then. The impact would be far greater, and the devastation could happen very fast.
Do you have an interest in this? Just your future.
(This article was written in 2004. Please see the Numbers at a Glance page for current amounts.)