Debt: The Mammoth in the room

The New York Times yesterday caught on that the US government has painted itself into a debt corner and has a diminishing capacity to merely service its debt, let alone be able to use government deficit spending to ’stimulate’ economic growth.  It is funny how the mainstream media cottons on to the real big issues about 5 years too late and about 10-15 years after the savvy analysts started highlighting the problem.  Human Action wrote about the scary reality of US government bankruptcy to our readers attention in October and here we aim to keep readers posted as the mess unfolds.

NY Times reports that:

With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

Of course, if the annual budget deficit were to be $2 trillion in 2019 (likely in our view), the interest payments would account for 35% of the annual budget deficit, and over half of total government revenues. In this case, the government would be issuing debt to cover its interest payments, and of course, in the absence of sufficient financing coming from elsewhere, would lead to outright monetisation of debt by the US Federal Reserve bank.  The NY Times again,

Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education.

Paul Volcker had to take the US Fed Funds rate from around 10% in 1979 to 20% in 1981 to squeeze inflation out of the system, triggering a 20-year bull run in the dollar and US Treasuries. When push comes to shove, just judging by historical precedent, Ben Bernanke (or whoever else is in charge at the time) may need to take the Fed Funds Rate well into double digits to avoid destroying the value of the dollar and overseeing a hyperinflationary depression. In that case we’re talking big increases in annual interest payments that would eventually become top-heavy and possibly cause a debt spiral, while higher interest rates will cripple the banking sector through rising defaults owing to higher borrowing costs.

NY Times: On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead.

As the guys over at Zero Hedge and Moody’s Ratings Service have us know, the US government needs to roll $6 trillion (and rising) every year, the US banking system has a $7 trillion roll maturity by 2012, and US commercial real estate has a $3 trillion refinancing cliff due around 2014. For those unfamiliar with finance jargon, when we say the debt must be ‘rolled’, it means existing debt must be paid off by the issuance of fresh new debt, i.e. you are approved for a new credit card which you then use to pay off existing credit card debt. It becomes very clear that once foreigners stop sending their hard-earned savings to the US, and when investors decide they’d prefer to preserve purchasing power by cashing out of US debt and putting money in US equities, foreign markets or even commodities, there will be some major dislocation and havoc in the capital markets that will reverberate through the global financial system.

Globally, government treasury departments are pricing in a very muted interest rate environment over the coming five years, as they are all, along with their central bankers, deflationists, meaning in simple terms they will print money to generate inflation at all costs.  We are in for a period of rapidly rising prices and interest rates in the not too distant future, probably from late 2011, being brought on by weakness of paper currencies, and that depending on the psychological state of the public by that time, we may be in for hyperinflation in the US and elsewhere, as currencies begin to decline rapidly.

Image courtesy of NY Times: