Total spending in our economy is the same, it's just a question of who spends the money, us or the government. This is a political question that we try to answer at each election. If I get an extra dollar, do I want to buy what private firms make or what the government makes?
A second important truth: If we don't save some of our money and put it in the "bank" (this includes insurance companies, stock brokers, and all that), then there is no money to be borrowed to "invest" in productive assets (finance the purchase of a new car or house or expand a business and hire new workers).
In 2007, consumers saved only about 1 percent of their after-tax income, a poor performance. It was 10 percent in the 1970s and early 1980s. Chinese consumers save 40 percent.
Small businesses get more than 90 percent of their operating funds from banks, which must depend on savers for the money to lend into the community.
If the government runs a $400 deficit and borrows the money by selling Treasury bonds to us, it reduces the amount of money available to finance investment. Since the Treasury will pay any interest rate it must in order to borrow what it needs (Why not? We pay it in taxes), private borrowers, who are sensitive to interest rates, will get whatever is left.
Bad sign: Low rates
The government deficit today is about $1.5 trillion. The government borrows about 40 cents for every dollar it spends. So why haven't interest rates risen to shut out private borrowing? In the recession, private spending, and the need to borrow to finance it, fell significantly. Car purchases fell from 15 million a year to nine million. So, less auto credit is needed. Housing starts are 1.7 million units lower than they were at their peak in 2006. That's a lot of missing construction loans - and jobs. A record-high percentage of small-business owners report having no interest in a loan.
In short, private credit demands are weak, so the large federal deficit is not affecting interest rates as much, especially with the Federal Reserve buying them up by creating new "money" - $600 billion in a program ending this month.
The private economy will recover, and with it the demand for money to finance 15 million new car purchases, a million new houses, and the expansion of millions of small businesses. Unless savings somehow increase substantially, private borrowers will have to compete with the government for our savings, and we know who will win that battle.
You might remember (in the 1980s) 17 percent mortgage rates, a 21 percent prime rate of interest, and 15 percent coupons on 10-year Treasury bonds.
Here's the bottom line:
We will be competing with the government to borrow money from the savings that consumers put in our financial institutions. If consumers save more, that will help ease the pressure, but consumers have been poor savers. The credit to finance growth will be harder to come by and more expensive as interest rates rise.
As the debt piles up, the burden of the interest payments will require more and more tax revenue to cover it. None of this is good for small business, which historically produces half of the private GDP (excludes government) and employs two-thirds of the private-sector workforce.
Paying the interest on $15 trillion to $20 trillion in federal debt will bring higher interest rates and higher taxes.
Let's hope our politicians have what it takes to start dealing with this before global financial markets decide to do the job. Two-year government bonds in Greece now have interest rates of 30 percent. No government can survive that for long, not even ours.
William Dunkelberg is a professor of economics at Temple University and a nationally recognized expert on small business and the small business economy. Contact him at firstname.lastname@example.org.