Wednesday, September 5, 2012

Beware: The U.S. Budget Will Completely Up End when Interest Rates Hit 5%

By Peter Schiff
As we head toward the end of the year, the media’s fixation with the congressionally imposed “fiscal cliff” will reach a fever pitch and no doubt become a major factor in the presidential campaign. The danger is supposed to arise from the simultaneous implementation of $2 trillion in automatic spending “cuts” (in reality, just reductions in the rate by which federal spending increases) and the expiration of the George W. Bush-era tax rates. Most economists fear that higher taxes and slower increases in federal spending will combine to send us back into recession. Despite the hand-wringing, it is certain that the lame-duck Congress will slap together a late-December, last-minute, can-kicking compromise that will buy time at the expense of long-term solvency. Any success in wriggling out of this particular budgetary straitjacket will just make it more certain that we head straight for another, larger, fiscal cliff that is hiding in plain sight.
As it is constructed currently, the U.S. budget will be completely and thoroughly upended when interest rates approach levels that would be considered normal by historical standards. A mere 5 percent rate portends a clear and present danger to the budgetary priories of the United States.

The current national debt is about $16 trillion. This is just the funded portion — the unfunded liabilities of the Treasury, such as Social Security and Medicare, and off-budget items, such as guaranteed mortgages and student loans, loom much larger. Our recent era of unprecedented fiscal irresponsibility means we are throwing an additional $1 trillion or more on the pile every year. The only reason this staggering debt load hasn’t crushed us already is that the Treasury has been able to service it through historically low interest rates (now below 2 percent). These easy terms keep debt-service payments to a relatively manageable $300 billion per year.

On the current trajectory, the national debt likely will hit $20 trillion in a few years. If, by that time, interest rates were to return to 5 percent (a low rate by postwar standards) interest payments on the debt could run around $1 trillion per year. Such a sum would represent almost 40 percent of total current federal revenues and likely would constitute the single largest line item in the federal budget. A balance sheet so constructed would create an immediate fiscal crisis in the United States.

In addition to making the debt service unmanageable, a return to normal rates of interest would depress the kind of low-rate-dependent economic activity that characterizes our current economy. A slowing economy would cut down on tax revenue and trigger increased government spending to beleaguered public sectors. Higher rates on government debt also would push up mortgage rates, thereby putting renewed downward pressure on home prices and perhaps leading to another large wave of foreclosures. (My guess is that losses on government-insured mortgages alone could add several hundred billion dollars more to annual budget deficits.) When all of these factors are taken into account, I think annual deficits could quickly approach, and then exceed, $3 trillion. This would double the amount of debt we need to sell annually...

By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rearview mirror. Most economists downplay debt-servicing concerns with assertions that we have entered a new era of permanently low interest rates. This is a dangerously naive idea.

For years, I warned that the bursting of the real estate bubble would trigger a financial crisis. My warnings routinely were ignored based on the near-universal assumption that real estate prices would never fall. That was wrong. My warnings about the real fiscal cliff also are being ignored because of a similarly false premise that interest rates will never rise. However, if history can be a guide, we should view the current period of ultralow rates as the exception rather than the rule.

Read the full article here.


  1. A great analysis by Peter Schiff. Going forward, regardless of the rate of inflation and of whether the economy booms or it just chugs along as it is currently, FED interest rates are not going up anytime soon. The budget deficit and national debt levels are simply too large to allow any significant raising of interest rates beyond what they are now. As Schiff notes, even at a historically moderate rate of interest of 5%, debt servicing would become completely unsustainable, much as it is today in Spain, Italy, and Greece.

    From an investment standpoint, you want avoid all non-inflation protected bonds and other fixed income investments because we are going to be stuck with significantly more inflation going forward no matter what happens with the economy. Gold, commodities, inflation protected bonds, stocks, and even real estate now that it has corrected are generally good investments from this perspective because they are all hedged for a inflationary environment.

    Also, don't buy into this "fiscal cliff" nonsense that Bernanke and some on Wall Street are pushing. Given the politics involved and the debt problems we face going forward, going over the fiscal cliff as it were is not all that bad. It would cut spending in real terms--a big rarity in DC--and it would take a decent bite upfront out of the deficit, not over 10 years or 30 years like Paul Ryan is talking about. Yes, the taxes aspect of it is bad, but, as Ron Paul has pointed out, as long as government is going to spending the money anyway, you are going have to pay the taxes on it either now or in the future, and it seems much better to pay it now.

    1. This is so true. As Chris Rossini wrote the other day: Default. Now. Let's get this over with, so to speak. And hopefully a default would signal to the people just how criminal the Federal Government and all its parts really are.

      We could go forward with greater freedom and opportunity to plan our lives again. And save at rates that aren't near negative. Imagine that. Still, I would love to see the legal tender monopoly die too. I'll never be satisfied until the market chooses money again. Gold and silver are my choices, naturally.

    2. "you are going have to pay the taxes on it either now or in the future, and it seems much better to pay it now. "

      Fuck that. How about Not paying now OR later.

      Besides, ever try squeezing blood from a turnip?

  2. Peter Schiff: Let's ban corporate profits!