Last week, Congressional Budget Office director Douglas Elmendorf testified before the House Budget Committee. His appearance drew little attention, but what he had to say was of considerable interest. In his initial testimony, Elmendorf described our current federal budget deficits as “unsustainable.” That prompted this exchange:
Q. In the report you use the term “unsustainable,” a term which a number of people use in terms of the current budget deficit track and a term I’ve used myself. …
I’m not sure that there is a complete understanding of the consequences of inaction here in this town. We use the term “unsustainable.” Can you be a little more specific and describe to us what that — what happens? We do nothing; we now look at deficits of $500 billion to $1.5 trillion as far as the eye can see; what happens?
ELMENDORF: I think a particular thing that’s unsustainable is to have federal debt constantly rising as a share of GDP because that requires a larger — ever-larger share of investors’ portfolios to be occupied by treasury securities. And at some point they will refuse to hold them, or will insist on much higher interest rates to do so.
So the thing that’s particularly unsustainable is expecting that investors will just constantly pile more and more of their portfolios — investors here and abroad — into treasury securities.
And what can go wrong is that interest rates can spike up when there is a crisis of confidence, and their sentiment about buying those securities changes.
But even before you hit that crisis point, of course, what’s going wrong in a more subtle — what’s obvious, but still very damaging way, is that the more of those treasury securities are being held, the less that investors will be holding of shares: the ownership of physical plant and equipment; the sorts of things that make our economy more — workers more productive over time and raises incomes over time.
Q: So what does that mean? Does that mean then we have much lower GDP growth? Does that mean that we — the federal government’s debt rating gets reduced, and we’re actually — and perhaps physically — unable to sell the debt at some point? I mean — I mean, what are the — what…
ELMENDORF: That — that’s all possible.
I think most observers expect that the government will act; that the unsustainability will be resolved through action, not through witnessing some collapse down the road.
If literally nothing is done, then eventually something very, very bad happens. But I think the widespread…
ELMENDORF: … view is that you and your colleagues will take action.
I think, on the contrary, that it is unlikely that Congress will take effective action–as opposed to seeking political cover–before grave damage has been done. In his written testimony, Elmendorf implicitly explained why:
The country faces a fundamental disconnect between the services that people expect the government to provide, particularly in the form of benefits for older Americans, and the tax revenues that people are prepared to send to the government to finance those services. That fundamental disconnect will have to be addressed in some way if the nation is to avoid serious long-term damage to the economy and to the well-being of the population.
We need deep and fundamental cuts in federal spending, which means, above all, Medicare and Social Security, because that’s where the money is. The whole concept of an “entitlement” was a mistake–really, a disaster–that must be repudiated. But for the foreseeable future, there will be no political will to make such changes. So we’re going to see a race between political will and economic collapse. It’s hard to be optimistic about the outcome unless a drastic change in our political culture takes place, soon.