Comment: U.S. should have locked in low rates for debt

Any homeowner will tell you: Adjustable rates adjust; that’s left the government paying more on its debt.

By Allison Schrager / Bloomberg Opininon

All the talk lately about the size of the national debt is obscuring the real problem: The U.S. government made the wrong bet on interest rates, and that will cost taxpayers for years to come.

The government took on an unprecedented amount of debt in the last five years. Reasonable people can disagree about the level of spending, but the clear policy error was choosing to finance that spending with short-term debt while rates were at record lows. Now that rates are rising, so are the costs of financing all this debt.

It didn’t have to be this way. We could have locked in rates when they were low. But at the time there was a pervasive belief that rates would never increase; even though, eventually, they always do. Now, as we face high debt service costs for decades, we can’t afford to ever forget this lesson.

We got used to low rates, since they have been well below 5 percent for nearly two decades and only seemed to go down. Now rates are rising and causing all kinds of disruption in many sectors of the economy. One saving grace is that many households have a fixed-rate mortgage that shields them from interest-rate risk. The government could have made a similar choice when it took out its debt. Borrowing short is the basic equivalent of taking on an adjustable-rate mortgage when a fixed-rate loan could have been obtained at an absurdly low interest rate. Now the government — and its taxpayers — face interest-rate risk that may limit spending in the future.

Outstanding U.S. debt increased to $30.5 trillion from $19.8 trillion between 2017 and the second quarter of 2022. A lot of that spending was used to get the economy through the pandemic disruptions. But in the years before, macroeconomists argued governments should spend more and not worry so much about debt because interest rates were so low. When rates are low, they said, the economic growth generated by the spending would more than pay for the cost of borrowing. If you borrow at 2 percent and invest the money in something that pays 8 percent, you’ll make a big profit.

But that thinking — just like many an asset manager selling a leveraged bet — was based on an assumption of no risk: that growth would be positive and interest rates wouldn’t increase. The government might have reduced its risk by locking in the low rates and issuing more long-term debt. A 20-year Treasury was yielding only about 1 percent in 2020. Instead, the government mostly financed its spending with debt that would mature in less than five years.

Financing its spending with short-term bonds means the government must roll over the debt as it comes due. The yield on a one-year Treasury is now more than 4.7 percent; compared with a 20-year rate of 1.46 percent the government could have locked in in 2021.

If rates continue to rise, even as inflation falls, this will impose big costs on the government and potentially taxpayers. The Congressional Budget Office calculated that if 10-year rates gradually rise to 4.6 percent, then servicing the debt will cost 7.2 percent of GDP by 2052. It was only 1.6 percent of GDP last year and hasn’t exceeded 3.2 percent since 1960. We should be so lucky. Interest rates already far exceed the CBO’s 2021 forecast, and are going up much faster. If rates rise to their historical average — above 5 percent — servicing the debt will cost far more.

The government had its reasons for issuing the short-term debt. If interest rates had stayed low forever, issuing short-term debt and rolling it over would have been cheaper than financing the spending with long-term bonds. After all, short-term rates tend to be lower than longer-term debt, and we saved a few basis points. Larry Summers co-authored a paper in 2016 examining the wisdom of financing debt with short-term bonds, weighing the benefit of lower costs against the risk of interest rates rising. If rates were anywhere close to their historical average, that is a reasonable question. But when rates are near zero, the risks clearly outweigh the benefits. Rates were at historic lows, which meant odds were they would eventually go back up. And they did.

The Trump administration’s Treasury Department also claimed that there was not much demand for long-term bonds. Though it’s not clear that’s true. The United Kingdom issues more long-term bonds. The average maturity on their conventional bonds is about 14 years, compared with about 5.5 years on U.S. debt. And the U.K. treasury (until very recently) found ample demand for long-term debt. Both insurance companies and pension funds tend to need more duration in their portfolios as they issue very long-term liabilities. Longer-term debt helps them hedge their risk.

But when rates were at historic lows, we made a different choice. And now we are all vulnerable to rising rates becoming a fiscal burden. It’s worth noting that average maturity on debt increased in the last year as spending fell and some short-term debt matured and didn’t need to be refinanced. But the average maturity of marketable debt has remained around five years, no matter the interest rate.

There are sharp divides among policymakers and economists on how much money was spent, how it was spent and if we should spend even more. But one important lesson they should all learn is no matter how much you spend, always lock in low rates when you can.

Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of “An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.”

Talk to us

More in Opinion

Editorial cartoons for Tuesday, Feb. 7

A sketchy look at the news of the day.… Continue reading

The Snohomish County Auditor's Office is one of many locations where primary election ballots can be dropped off on Tuesday. (Sue Misao / The Herald) 20180806
Editorial: Voting’s a duty, but should it be mandatory?

Legislation to require voter registration and voting needs more discussion among the public, first.

Marysville schools working hard to improve, help them with levy

As an educator in Marysville, I feel compelled to share how important… Continue reading

HeraldNet app allows me to keep up with news

First I was pretty miffed. I’m 76, my wife says I’m a… Continue reading

Ban net-pen fish farms in federal waters, too

As we go into 2023, we all want to start the new… Continue reading

Saunders: If Hunter Biden’s looking for cash, he’s in trouble

He hasn’t faced criminal charges before for his indiscretions, but that may be changing soon.

Herald columnist Julie Muhlstein received this card, by mail at her Everett home, from the Texas-based neo-Nazi organization Patriot Front.  The mail came in June, a month after Muhlstein wrote about the group's fliers being posted at Everett Community College and in her neighborhood.  (Dan Bates / The Herald)

(Dan Bates / The Herald)
Editorial: Treat violent extremism as the disease it is

The state Attorney General urges a commission to study a public health response to domestic terrorism.

Photo Courtesy The Boeing Co.
On September 30, 1968, the first 747-100 rolled out of Boeing's Everett factory.
Editorial: What Boeing workers built beyond the 747

More than 50 years of building jets leaves an economic and cultural legacy for the city and county.

Marysville School District Superintendent Zac Robbins, who took his role as head of the district last year, speaks during an event kicking off a pro-levy campaign heading into a February election on Thursday, Jan. 5, 2023, at the Marysville Historical Society Museum in Marysville, Washington. (Ryan Berry / The Herald)
Editorial: Voters have role in providing strong schools

A third levy failure for Marysville schools would cause even deeper cuts to what students are owed.

Most Read