Today, the interest rate doomsayers are still shrieking about the government's demand for credit. They say Washington must cut spending now in order to reassure the markets that the United States will be able to pay its debts in the long term. "The US will reside in the debt danger zone for the foreseeable future in the absence of action," wrote Douglas Holtz-Eakin, a former director of the CBO.
These fears are overblown. The Treasury could double the interest payments on every single bond, note, and bill outstanding today, and the overall cost would still be lower as a share of GDP -- about 2.8 percent -- than at many times in the late 1980s and early 1990s.
Granted, interest rates in the markets can change quickly (just ask any European finance minister), but interest rates on the entire federal debt can't change that quickly. The reason, as I've pointed out here before, is that the Treasury has been steadily lengthening the term of its borrowing. This means those debts don't roll over nearly as often as they used to, and the country has more time to plan for changes in interest rates.
Moreover, the markets likely believe that the debt will come down naturally, for reasons that Nobel laureate Robert Solow recently pointed out in an op-ed for the New York Times. When strong growth returns to the American economy, tax revenue will rise and debts will be paid off, making more room for private borrowing.
For now, however, growth is sluggish and investors are still eager to buy American debt; the Treasury's last auction for 30-year bonds was almost three times oversubscribed. With the eurozone in trouble and Japan pursuing higher inflation, there are few safe places to park one's money. Yet a recovery in the eurozone or an eventual return to price stability in Japan won't bring on any sort of debt crisis in the United States. Either of those would signify a return to growth abroad, which would create demand for American goods and services as well. Faster growth in the United States would lead to smaller deficits and a smaller-than-expected national debt.
Under these circumstances, the interest rate doomsayers would be wrong again. Problems abroad are holding back growth in the United States (as are premature budget cuts here at home, according to Solow). As long as they do, the Fed will keep flooding the markets with money, investors will keep flooding the Treasury with money, and interest rates will stay low. When the problems abroad sort themselves out, interest rates may indeed rise -- but the national debt will shrink at the same time.
None of this will come as any surprise to people who work on Wall Street instead of in Washington. Financial analysts and economists don't see any urgent threat of higher interest rates or unsustainable debts; if they did, then interest rates on Treasury securities would already be higher today. No, the only threat is the one that people in Washington have conjured up to justify deep cuts in federal spending. Why would anyone listen to them?