via WOLF STREET:
We have a situation here. Folks are out there promoting the idea that the Fed cannot keep interest rates at 4.5% for long, and that it certainly cannot hike interest rates to 5.0% or 5.5%, because the amount that the federal government pays in interest expense is spiking and the government cannot afford to pay the spiking interest expense, and the Fed will have to pivot any moment now and cut interest rates because otherwise the government would go bankrupt or whatever.
This stuff is now everywhere, propagated by all kinds of newsletters, and by bond fund managers and hedge fund managers that are losing their shirts with these higher interest rates, and the pivot mongers have grabbed a hold of it, and they’re on TV with this stuff, pushing the idea that the Fed must cut interest rates or else the government will go broke or whatever.
What these pivot mongers are willfully omitting is that tax receipts – which pay for the interest expense – have spiked by a huge amount, and that interest expense as a percent of tax receipts had hit a historic low in Q1 2022, and has ticked up from that historic low but remains near historic lows. Interest expense as a percent of tax receipts is the primary measure of whether or not the government can afford the interest expense: It was around 50% in the 1980s; in Q3 2022, it was 22.9%:
The thing is, inflation has been huge. Inflation means that government tax receipts are spiking, thereby lowering the burden of paying for the existing debt, thereby allowing the government to borrow more because the burden of the old debt gets extinguished by surging tax receipts due to inflation, which is why governments love inflation.
But inflation is an enemy of the people. And when inflation rises beyond certain low-ish levels – the Fed thinks that’s about 2% per its core PCE measure – it will ultimately tangle up the economy, leading to all kinds of long-lasting damage. And that puts the brakes on the government’s wishes to inflate away the results of deficit spending, namely ballooning debts and interest expenses.
