Wars cost money, and throughout history, countries have borrowed to fight them. There are plenty of examples of wars bankrupting countries, but the US was so dominant in the 1940s that at the end of World War II, its debt only cost about 1.8% of GDP to service. By 1959, debt service was back down to 1.1% of GDP.
Policymakers then got complacent about the budget in the 1960s and 1970s. Great Society programs included Medicare and Medicaid. Vietnam's spending was huge. The Fed attempted to monetize all this spending, and inflation sent interest rates higher. The result: between 1982 and 1998, interest on the national debt averaged about 3.0% of GDP.
But as rates rose, the US worked to get its act together. Reagan spent to win the Cold War but slowed spending in other areas. The peace dividend that resulted as well as budget deals between Clinton and Gingrich led to balanced budgets. In turn, the interest burden started heading back down. Between 2000 and 2020, interest on the national debt averaged 1.5% of GDP.
And even though spending soared during the 2008 financial panic and COVID, the Fed was holding interest rates artificially low, and monetizing some of that spending.
But just like the 1970s, the US is paying the price. Interest costs last year were 1.9% of GDP, the highest since 2001. We’re projecting this year will be 2.5% of GDP, the highest since 1998.
Unlike the 1980s, however, politicians don’t seem interested in changing course. The US isn’t Argentina, but as the interest burden climbs back to 3.0% of GDP, we believe it will capture the attention of more politicians, who won’t like sending so much money to bondholders. In turn, that should generate some bipartisan interest in finding ways to bring the interest share of GDP back down.