Great Minds Think Alike: John Cochrane Edition

Last week I highlighted Michael Bloomberg's bewildering fantastical financial perspective.  I talked about how even an infinite amount of money (which doesn't exist) isn't much good at high and rising interest rates and that a "debt death spiral" is a possibility.

What Nannyberg seems to not want to discuss is that the terms upon which people lend us money are renegotiated almost every day. Those terms are going to change in the near future and the terms are going to get increasingly onerous.  At some point, an infinite amount of money (or even just alot) is meaningless, there are terms under which one shouldn't and won't borrow.  The vast sums of nearly cost free money that we now spend with reckless abandon is an historical anomaly and it will shortly disappear.  Lenders will start to demand a rate commensurate with a) our debauched creditworthiness, and/or b) the prospect of ultimately receiving devalued dollars in return as repayment.  When this process gets well under way, the costs of our fiscal incontinence will go way up and the pain will not be from cutting spending, the real pain will be from keeping spending.  You see, the miracle of compound interest works in reverse too.  Debts compound rather quickly at increasing interest rates, and if they rise fast enough, it is nearly impossible to avoid a debt death spiral.

In today's WSJ, U of Chicago economist John Cochrane talks about the same thing, lays some numbers down, and posits a potential "fiscal death spiral" as well. 

But this comforting thought leaves out a vital consideration: Monetary policy depends on fiscal policy in an era of large debts and deficits. Suppose that the Fed raises interest rates to 5% over the next few years. This is a reversion to normal, not a big tightening. Yet with $18 trillion of debt outstanding, the federal government will have to pay $900 billion more in annual interest. ...

This additional expenditure would double the deficit, which tempts a tipping point. Bond markets can accept fairly big temporary deficits without charging higher interest rates—buyers understand that bigger deficits for a few years can be made up by slightly larger tax revenues or spending cuts over decades to follow. But once markets sense that deficits may be unsustainable, and that bond buyers may face default, restructuring or inflation, they will demand still-higher interest rates. Higher rates mean higher deficits—leading to a fiscal death spiral. 

Read the whole thing.