The Debt Bomb

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According to Treasury Secretary Jack Lew, the US government will reach its debt limit of $18 trillion on November 3, halting any further borrowing by the feds. Predictably Lew is prophesizing the end of the world if the limit isn’t raised beforehand, “I worry every time we hit this that sometime there would be an accident, and that would be terrible.” A terrible accident? You mean like making IRS, NSA, and TSA employees wait a little longer for a paycheck? You mean like a few less drone murders? You mean like actually forcing the feds to reign in spending? Oh, the horror!

Lew is trying to convince Congress and the public that if we aren’t able to borrow more then the US government will default, sending interest rates through the roof and punishing Americans who need to borrow money to buy a car or a home. That’s not going to happen and Lew knows it. Default is defined by the credit rating agencies and bond investors as the inability to make interest and principal payments on US government debt (Treasury Bills, Treasury Bonds, US Savings Bonds, etc.). Every month the federal government takes in roughly eight times as much cash as it needs to make these payments. The only way the feds could default is if they did it on purpose!

The people who make a living off US debt, bond traders and investors, know this and that is why interest rates are still near record low levels. So why is Lew making this ridiculous prediction? Because scaring simple minded Congressmen is the best way to get what he and the President want – the ability to borrow and spend an unlimited amount of money.

And that’s the real problem.

The current administration is the beneficiary of a sputtering economy that keeps the demand for money low. Low demand means the price of money, the interest rate, will also stay low. As long as rates are low the feds can continue to borrow boatloads of cash without having to pay out a lot for doing so.

Since Obama became President the government has nearly doubled the national debt from just under $10 trillion to over $18 trillion. It’s projected that by the time he leaves the White House the debt will be well over $19 trillion and on its way to $20 trillion within the following year. Paradoxically, the feds actually pay out less in interest now than they did in 2008 – $403 billion now versus $409 billion in 2008. This isn’t because of any financial wizardry by government officials. It’s because interest rates are currently 2 to 16 times lower than they were in 2008.

So, how is this a problem? Sooner or later the economy will fully heal and take off once again. The demand for money to borrow will skyrocket. If you paid attention in Econ 101 then you know anytime the demand for something goes up so does the price. If the demand for money goes up then the price of money will too, returning interest rates to a more normal level. What is a normal level? Lets compare today’s abnormally low rates to 2008’s.

Right now the government only pays out 0.10% interest on money it borrows for less than a year (T-bill). In 2008 it paid 1.6%; sixteen times more. If the feds borrow money for two to ten years (T-Bonds) it currently pays about 1.8%. In 2008 it paid 4.1% for the same maturity. And if they borrow money for twenty to thirty years, the fed now pays 2.7% versus 7.1% in 2008.

The rates in 2008 were about average for the history of the country. We will see those rates again, probably sooner than later. When that happens the interest that the government has to pay will explode. If the economy fully recovers by the 2nd year of the next President’s term, forcing interest rates to a normal level, and the total debt grows to $21.64 trillion, as predicted by the Congressional Budget Office, the feds will be forced to pay out $910 billion in interest. That’s nearly a trillion dollars! That’s more than we currently spend on defense and almost as much as social security.

Right now, for every $8 you send the government in income taxes, FICA, gasoline taxes, etc., they pay out $1 to someone to whom they owe money. By the end of 2019 they could be paying out $1 for every $4 you send them. And it will only get worse. Unless something is done to drastically reel in spending, interest on the debt will become the biggest part of the federal budget. It will continue to grow like cancer until it eventually sucks up every dollar of tax revenue. Then defaulting on the debt will no longer be a scare tactic to be wielded by the Treasury Secretary. It will become an unavoidable crisis that makes the Great Depression look like a picnic.

The Obama administration could have pushed the day of reckoning far into the future by converting short-term debt to long-term (30 year) while interest rates were low – but they didn’t. Instead they pushed the bulk of their borrowing into mid-range debt, the two to ten year bonds. These bonds will come due during the next President’s term forcing him to borrow trillions and trillions of dollars at what will probably be much higher rates. Obama and Lew are their successors the financial equivalent of a pile of Bo-crap on the Oval Office carpet. Unfortunately this mess won’t be nearly as easy to clean up.

Wayne Middlesteadt is the author of Five Ways to Beat the Market and The Golden Age of Distance Running.

About Author

Wayne Middlesteadt is a 1986 graduate of Georgia Tech and has an MBA from Georgia State University. Currently working as a financial writer and track and field historian, his latest book is Five Ways To Beat The Market.