Thursday, April 09, 2009

Converting federal debt to hell: the tipping point

I have already described some of the costs of bearing a large national debt in terms of regular-every-day economics of supply and demand. Upon further reflection, these costs are small when compared to the possibility that the debt will someday turn all that remains of our entire wayward economy into a pillar of salt. The end is near.

As you pore over this dense post to decipher the secrets of our imminent demise, do not fall into the trap of comparing our situation too closely with that of Argentina just a few years ago. Careful analogies may be drawn, but keep in mind at least two of the many differences: Argentina is tiny, and in the years leading up the crisis, Argentina had its currency tied to the dollar.

The US federal government is in debt by over $11 trillion. Who cares? Right now, with interest rates on treasury bills near zero, the US is paying approximately no interest on the debt. However, rates on government debt have varied widely. In 2006, rates on 6-month bonds were at about 5% (annualized). The point is that a small change in the interest rate makes a big change in how fast the debt grows. Even a 1% rate increase means that we lose $110 billion more per year (1 percent times 11 trillion).

Why is it that interest rates on government debt are the lowest in the world? There is no law that sets these rates; the rates are entirely dictated by supply and demand. In fact, the only reason that rates are low is that people (and foreign nations) like to put their money somewhere safe, and the US has never ever defaulted on its debt.

Now it's not like this would ever happen, but just suppose for a moment that the US is going through some kind of economic turmoil. Things go a little wacky, no one knows exactly what is going on, and somehow we end up with an interest rate of 10%. Let's see how things might play out with regards to the federal debt:
  • The debt grows more quickly, perhaps by 8% per year (assuming a 2% inflation rate).
  • High interest rates at home mean that fewer people can buy houses or cars or education. The economy shrinks. This leads to lower tax revenue, so the debt grows even faster.
  • People who are lending the US their money get just a tiny bit worried. They are pretty sure that the US would never default, but they consider it a big enough risk that they decide to lend to the US only at 11% instead of 10% interest. As described in the first two points above, this makes everything even worse.
  • The US politicians get scared that they won't win the next elections (just three years away) if they don't do something quick. The only thing that works quickly is a lot of government spending. So we go another trillion into debt to pay for that.
  • Lenders see what the politicians are doing and realized get a little more worried. They charge 15% on the debt, up from 11%. As mentioned above, this makes things even worse for the US.
  • Then the lenders start looking at each other. They notice that everyone is worried that the US might default. Even though Lender A doesn't think that the US will default a priori, he knows that all the rest of the lenders might be more worried than he is. And if all the rest of the lenders get too worried, then they will completely stop lending, and the US will have no choice to default. Of course, this is all only hypothetical in the mind of Lender A. But just in case, Lender A refuses to lend to the US for any less than a 25% interest rate.
  • All the lenders are like Lender A. On speculation that future interest rates will be higher than current ones, investors refrain from lending to the US in the present. It's like a "reverse bubble."
  • At some unpredictable moment, interest rates rise exponentially, perhaps causing the US debt to double annually, and everyone realizes that there is no way for the US to pay back its debts. Then no one lends anything to the US anymore. The government goes into default. Terrible things happen (not sure exactly what, but believe me, it will make you wish your home was Calcutta).
This is bound to happen if the national debt continues to grow much faster than our GDP, which appears likely for quite some time. Exactly when it will happen is uncertain. The Second Coming -- of the financial crisis -- will come like a corporate executive in the night, floating down from the sky beneath a golden parachute.

Clever demons will arise and try to confuse you with statements like, "interest rates in the US will never get high enough in the US to cause problems because the Federal Reserve knows how to keep money cheap." But remember this so that you will recognize their lie for the fruit it produces: high inflation rates cause rapid devaluation of government bonds. Foreign investors will hold out for even higher interest rates to make up for this devaluation, the descent into hell will proceed only faster.

Take heed, not all is lost (which is much different than to say "all is not lost" -- most things will indeed be lost). If you act soon enough, you can be spared from the worst of the famine that is sure to follow. Take your money now, and do not invest it in government bonds, where future default will destroy, but instead invest in land in West Virginia, the little Afghanistan of the US, where it is easy to hide among the hills, easy to establish strong defenses, and where there is enough ginseng and wild onions and squirrels to sustain you and your children into the next generation.

2 Comments:

Anonymous goodbadi said...

Or why not the 33 acres down the road from us? With the double-wide?

5:10 PM  
Anonymous happypappy said...

But there are still neighbors who can be parranoid, for all we (they) know.

wild onions = ramps

12:24 PM  

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