Tuesday, July 5, 2011

The Scary Deficit Numbers, Once Interest Rates Start to Climb

Pat Buchanan has an important article over at LRC. He calls for Republicans to stick to their guns and not raise taxes. It's doubtful the tax line will be held. But that is not why the article is important, it is important because Buchanan outlines what is going to happen to the budget once interest rates start to increase. This needs to be  understood. Here's Buchanan:
As President Bush prepared to invade Iraq in September 2002, the head of his economic policy council, Lawrence Lindsey publicly estimated such a war could cost $100 billion to $200 billion.

Lindsey had committed candor, and the stunned Bushites came down on him with both feet.

"Baloney," said Donald Rumsfeld. The likely cost would be $60 billion, said Mitch Daniels of the Office of Management and Budget. We can finance the war with Iraqi oil, said Paul Wolfowitz.

By year's end, Lindsey was gone, back, in Ronald Reagan's phrase, "testing the magic of the marketplace."

And the cost of the Iraq War? It has passed $1 trillion.

So Lindsey is worth listening to. And he is now saving that the Obamaites may be wildly underestimating the deficits America is going to run in this decade. Here is why.

The average rate of interest the Fed has had to pay to borrow for the last two decades has been 5.7 percent. However, President Obama is projecting the cost of money at only 2.5 percent.

A return to the normal Fed rate would, by 2020, add $4.9 trillion to the cumulative deficit, says Lindsey, more than twice the $2 trillion in savings being discussed in Joe Biden's debt-ceiling deal.

Second, Obama is estimating growth in 2012, 2013 and 2014 at 4, 4.5 and 4.1 percent. But the normal rate for a mature economy recovering from recession is 2.5 percent.

Hence, if we return to a normal rate of growth, rather than rise to Obama's projected rate, says Lindsey, that would add $700 billion to the deficit over the next three years and $4 trillion by 2020.

Taken together, a U.S. return to a normal rate of growth of 2.5 percent, higher than today, and a normal rate of interest for the Fed could add as much as $9 trillion to the deficits between now and 2020.

New taxes on millionaires and billionaires who ride around in corporate jets can't cover a tenth of 1 percent of these deficits.

Writes Lindsey, "Only serious long-term spending reduction in the entitlement area can begin to address the nation's deficit and debt problems."

His conclusion is logical, but seems impossible to achieve when both parties are talking of taking Medicare and Social Security off the table. Which makes his final point all the more compelling:

"Under current government policies and economic projections, (bondholders) should be far more concerned about a return of their principal in 10 years than about any short-term delay in interest payments in August."

Lindsey is saying that the probability of U.S. bonds losing face value through inflation or default is high, given the size of the deficits we will be running and the improbability that any deficit-reduction plan now out there can significantly reduce them.
The only objection I can raise to the Buchanan-Lindsey argument is that interest rates are not going back to the average of the last two decades of 5.7 percent. Rates are going to climb to the double-digit rates of the early 1980's, and it is not going to take until the year 2020 to get there. At best, we have three years, but I suspect within a year, by mid-2012, everyone is going to understand that government finances are in real trouble. Investors won't want to own short-term Treasury securities paying less than 7 percent to 10 percent (The 6 month yield is currently only one-tenth of a percent) . At some point after that things will move very rapidly and the United States government will be paying interest rates comparable to those paid by banana republics.

Interest rates are already starting to climb. Price inflation is continuing to accelerate, and as soon as the debt limit is increased by Congress (As it will after more posturing), it will result in even more pressure on interest rates, as the Treasury expands its borrowings. The gig is just about up. No way does the financial structure of the United States government survive in its present form until the year 2020. As Buchanan says it is either default or huge money printing by the Fed. Bet on big time money printing, and bet on the money printing to start before the end of the year.(And it won't be phony quantitative easing). By the time it ends, years later, we may have our first, in nominal dollars, quadrillion deficit (That's what comes after 999 trillion dollars)becasue of the amount of money the Fed will print.

If you forgot, or weren't around to see what interest rates were like in the early-1980's, here's a CBS news clip from 1980:

The prime rate peaked in 1981 at 20.50 percent.


  1. In the 1980's how was the U.S. able to maintain high interest rates and high deficits at the same time?

  2. The deficit in 1980 was under 3% of GDP. It will be over 10% at the end of 2011.

    Plus the bills weren't coming due on medicare, medicaid and social security, the way they will be in the not too distant future.

  3. It should be abundantly obvious to anyone that talk of cutting spending and lowering tax rates is just that- talk, nothing more. This is not a conspiracy theory, just an acknowledgement of the facts. The bill for all of this recklessness for the past 50 years will come due and no one in public office now wants to be standing when the music stops. The national economy has been pushed to the cliff intentionally, inch by inch, decade after decade until there is no mobility left. We have politicians who largely ignorant of the direction those who influence them e.g. ideologues want all of us to go. This is not an apology for the poor public servants, merely an observation that we have allowed through our apathy or endorsement, people to control us through government and to use that power to make us and our children slaves. Things are going to get extremely ugly in this country over the next few years, because we (as a country) are only dominant so long as other nations see us that way- once they stop believing it, we stop living it. We have been wounded from the inside and our enemies lie in wait for the moment to exercise their power in the vacuum we created. Once the stuff starts flying, talk of the future economy will be consumed with the question of survival in the present.

  4. He means over 100% of GDP at the end of 2011. We are almost there, once they raise the debt ceiling we will be.