Should our economy be a carrot or a stick? Welcome to the call brought to you today by Bloomberg Government. I'm Jay Sapsford, live from the Decatur House here in Washington. America's military is the world's biggest, but its power also flows from the dollar, from trade, and from deep capital markets. And many are uneasy with us leveraging our economic clout for national security. So today our question: how should the US deploy economic power? And we can think of no one better to address this question than Janet Yellen, a distinguished fellow at Brookings Institution. She's the first woman to have led both the Federal Reserve and the US Treasury. Secretary Yellen, welcome to the call.
Thank you so much for the invitation. It's a pleasure to be with you.
So let me start with this. The US economy is known for being open, and that openness has long been a source of our power. It also has been, in recent years, underscored that it's also a source of vulnerability, and we've had to put up a lot of restrictions in order to protect ourselves. When do those restrictions cross the line into protectionism?
Well, let me start by agreeing with what you said, which is that our openness has been a tremendous contributor to economic growth and the improvement in welfare. And I'm thinking here not only of trade, which, you know, economists argue about all kinds of things, but the one thing I've never heard disagreement about is that trade is something that overall enhances economic growth and welfare, which is not to say that it doesn't impose some harm, which is important to address, but overall it's been a big spur for growth. Having open capital markets, welcoming foreign investment to the United States, technology transfer, our investments abroad, very important, and people and talent coming to the United States and starting new businesses and helping business grow. So I agree about openness. Nevertheless, there are some limits, and in recent years we've seen what they are. During the pandemic, we found our supply chains, which had become very efficient, very global, very complicated. Our supply chains were a source of vulnerability.
The shutdown in China, with great dependence for PPE, personal protective equipment, active pharmaceutical ingredients, and semiconductors. You know, we found that we couldn't operate automobile factories. We would just lack the semiconductors that go into cars. And we realized that we had focused on efficiency beyond the point where it was wise, at least for the nation as a whole.
Individual firms have focused more on supply chain resilience, and the United States as a country, in some cases, I think, seeing that there are real national concerns tied to our supply chains, needs to step in and maybe subsidize to make sure that we have alternative sources of supply. And on national security, I think it makes sense. I think it's widely agreed that we make sure that sensitive technologies that would improve military capabilities for countries that are not our friends, that we should be careful they not get into those hands. We have to be careful to place some limits on this, though, because we can, you know, begin by identifying a few areas where we have national security concerns where there would be broad agreement. I think advanced semiconductors, quantum computing, but really almost any industry in the United States could begin to make the case that they're critical to national security. And we have to be careful that this not drift into pure protectionism, which is a downside risk and could be very costly.
We're putting up a chart. We've been talking about how America uses its economic power abroad. I want to turn to something that could weaken that power here at home. This year, the US is expected to spend more than $1 trillion just on servicing its national debt. That's more than we spend on defense. But look at where that's headed. The Congressional Budget Office projects that those interest payments will double in the next 10 years to $2.1 trillion. So here's the question: at what point does America's debt become a constraint on America's economic power?
Well, in a way, I think it already has become a constraint, because $1 trillion, I think that's roughly 3.3% of GDP. That is really beginning to push the limits of what we have spent historically on interest payments. Interest expense since the pandemic has gone way up, and we now have deficits that are threatening to, as your numbers show, escalate that over time. I think by 2036 we would be looking at something like interest rising to over 5% of GDP. And to pay that, well, look, our budget deficits this year will be over 6% of GDP, right?
And we virtually never experienced that except at times when we were at war or in a deep recession. And so we have large deficits when, you know, we actually lived in an economy, I remember this very well because I was at the Fed most of this time, when short-term interest rates actually remained at zero for seven full years and long-term interest rates were very low. I still remember before the pandemic when some people got mortgages with two or three as the first digit. But we're not in that world anymore. Interest rates are much higher. The burden of the debt, in terms of the amount we have to spend on interest, is much higher, and we really need to do serious deficit reduction to get ourselves on a sustainable path. So look, you know, when you're looking at deficits that large and such a large share being interest payments, it constrains what you feel you can spend on, and every expenditure threatens to make this situation worse.
But this is not unique to the United States, right? We saw some of the activity in France, for example, which has some very unique problems that are specific to France. But at the end of the day, you know, they're looking at a situation where they can't afford it. Japan has deficits that are very large as well. And these levels of outstanding debt across the entire advanced world seems like that might be something that could compete with private capital.
Well, I think that you're absolutely right. The United States is not the only country in this fiscal situation. We all, you know, most advanced economies face aging populations. We're seeing social spending in the United States, that's mainly Social Security and Medicare, rising as a share of GDP, and tax collections not keeping up with that. In fact, in the United States, we've cut taxes. It is a developed country problem. And I agree with you. I believe it is an important factor that's pushing up interest rates. When private investment spending was very weak, the government didn't have to pay very much to attract capital to be able to finance those deficits. But now we're seeing a boom in AI spending, right? And issuance by the hyperscalers of long-term debt that's competing with US government debt. And it's a global economy, and really this is a global phenomenon, and an understanding that we're probably now in a world where interest rates are going to be, on a longer-term basis, higher than they were after the Great Financial Crisis.
So an era of structurally higher interest rates.
Yes. And I think that's one of the realizations that has been driving the increase in interest rates. Also the fact that inflation has been chronically now in the United States for more than five years now above the Fed's target. And while I think there is confidence in the Fed that remains, and its willingness and ability to address inflation, it requires higher interest rates. And so at least over the next several years, I think most market participants have moved up the level of short-term rates that they think we're going to be seeing.
Well, you mentioned the deficits that we're facing and the rising debt burden. We've got about $40 trillion in outstanding right now. If we're going to reduce that, what are the levers that we can pull on? Can we grow out of this? What about taxes, spending, entitlements? What if you had a magic wand, what would you change?
Well, okay. So the three big drivers are taxes, Social Security, and Medicare. So the first thing I would say is that anybody who thinks that addressing waste, fraud, and abuse or non-defense discretionary spending, that they can find a solution there, that is absolutely wrong. That amounts to a trillion dollars essentially in total, and it has been falling as a share of GDP, and it's been pretty much cut to the bone. I'm not seeing a lot of sentiment on either side of the aisle that we can make substantial cuts in defense spending either. And that takes us to two programs that are critical, that Americans love and don't want to see cut, namely Medicare and Social Security, and taxes, which the number of supporters of raising those doesn't seem to be overwhelmingly high. And so this is root canal economics. This is not fun. And I doubt that you're likely to see in our next presidential elections candidates on either side of the aisle that are going to be making proposals for how we can deal with the deficit. And that's really a problem, because that is something we very much need to do.
