We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are

Life, Liberty and the pursuit of Happiness.

That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed,

Wednesday, April 07, 2010

What Happens When Interest Rates Rise?

On March 23, we made history. No, it wasn’t the signing of Health Care Reform (although I’m sure that this bill is a contributing factor), but on the same day the health care bill passed, U.S. government debt lost its "risk-free" status.

That day, for the first time in over a generation, the U.S. government was a worse credit risk than a U.S. company.

Specifically, investors were willing to accept a lower interest rate to lend money to billionaire Warren Buffett's company, Berkshire Hathaway, for two years than to lend to the U.S. Treasury for the same period of time.

Two weeks before the House vote, the Congressional Budget Office (CBO) released its estimate of Obama's budget, including its health care program. From 2011 to 2020, the cumulative deficit is almost $10 trillion. Adding 2009 and 2010, the total rises to $12.7 trillion.

In 2020, the projected annual deficit is $1.25 trillion, equal to 5.6 percent of the economy (gross domestic product). That assumes economic recovery, with unemployment at 5 percent. Spending is almost 30 percent higher than taxes.

Total debt held by the public rises from 40 percent of GDP in 2008 to 90 percent in 2020, close to its post-World War II peak. It will so surely end up being a financial disaster that the bond market has actually begun to price government obligations at higher interest rates than highly rated private companies...

The problem is, once creditors begin to fear more and more paper will simply be printed to pay these debts (and, of course, that's what will happen), interest rates will rise. And they could rise suddenly. That would force governments to spend vastly more money on interest payments than they expect. That's the big problem right now in Greece, for example. Many believe that by the end of Obama’s first term the U.S. will owe roughly: $17.8 trillion in federal debt, $2 trillion in GSE debt/guarantees, $500 billion in FDIC obligations, and $500 billion in FHA obligations.

What's a reasonable rate of interest on these debts? Right now, it costs the U.S. government almost 5% to borrow for 30 years. Let's assume the blended borrowing cost goes to that amount – which is well below the government's average borrowing costs since 1980. That would equal $1 trillion in interest payments due, per year. That's 100% of all income taxes paid in 2009.

I hope I don't have to explain to you why this amount of debt isn't sustainable. I'm not the only person in the world who can do basic math and has access to the government's accounts. One of Europe's top money managers stated, "Eventually the U.S. will arrive at the point where, interest payments on government debt all of a sudden go to 20%, 25%, 30% of tax revenue. And once you go above 30%, you are done. You go into default or your currency breaks down and your system collapses."

Yesterday Greek bonds were going at rates of 7% and every day our entitlement-economy looks much closer to theirs than it did at the end of the Clinton administration.

Even more worrisome, is that the administration has just signed into law (buried in the jobs bill, again without a peep from the media) capital controls designed to not let you escape when the meltdown occurs as if they are actually planning for this to happen.

Some blogs are now starting to report that this is a set-up for grabbing your personal retirement accounts, I’d like to think not; but the ongoing actions of this government are becoming harder and harder to rationalize, even for my most liberal friends.

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