As Obama unveiled his whopping $3.73 trillion federal budget, his treasury secretary is reportedly warning him that such profligate expenditures cannot continue. What he is saying is this: The government will simply not be able to borrow the $10-15 trillion it needs in the next ten years at the low interest rates it expects. The results? Our interest costs will soar.
Why is this? Because of supply and demand. That much borrowing creates a huge supply of treasury bonds that simply overwhelms the global demand for such bonds, and bond prices drop, driving up interest rates. Within a few years, interest expense becomes the greatest expenditure in the budget. This chart is from an official U.S. government report to Congress. As you can see, it is projected that interest on our exploding national debt is going to spiral out of control if we continue on the path that we are currently on. And if, as I forecast, we have a bond crisis that drives up interest rates, the day of reckoning will arrive much sooner.
Ben Bernanke, Fed chairman has also joined the chorus of economic leaders warning about the unsustainability of our deficits:
“If government debt and deficits were actually to grow at the pace envisioned, the economic and financial effects would be severe,” Federal Reserve Chairman Ben S. Bernanke told the House Budget Committee Feb. 9. “Sustained high rates of government borrowing would both drain funds away from private investment and increase our debt to foreigners, with adverse long-run effects on U.S. output, incomes, and standards of living.”
The drumbeat of warnings on unsustainable public debt levels across the globe continues. Economic luminaries Geithner, Bernanke, Greenspan, and Volker are all saying the same thing. Add to this chorus a recent paper published by the Bank for International Settlements (BIS), the prestigious “central bank of central banks” issued another warning on unsustainable public debt levels across the globe. Here are some quotes:
“Our projections of public debt ratios lead us to conclude that the path pursued by fiscal authorities in a number of industrial countries is unsustainable. Drastic measures are necessary to check the rapid growth of current and future liabilities of governments and reduce their adverse consequences for long-term growth and monetary stability.”
“In some countries, unstable debt dynamics, in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels, are already clearly on the horizon.”
Our deficit problem is really a spending problem. Look at how much the government is spending relative to the size of the economy:
The real issue is that there is little political will to reduce spending. And the problem does not lie with the politicians alone, but with the voters. While the Republicans recently elected may think they have a mandate to reduce spending, they are finding little popular support to touch Social Security, Medicare, defense, education or any other program of any size. In recent polls, the majority of Americans agreed we need to reduce the deficit, but the only program they wanted to reduce was foreign aid!
This is one of the problems with democracy: you can vote yourself money! Given that most Americans now receive some form of support from the government, I see no way spending will actually change until there is a crisis.
This is why I am sure my scenario will play out as forecast: we will have a bond crisis, where interest rates spike as creditors simply say “no” to continued lending to the US at low rates. Shortly thereafter or simultaneously we will have a currency crisis, where the value of the US dollar falls, as the government resorts to its only alternative: “printing” more money.
A falling dollar causes 1) interest rates to rise even more; and 2) inflation. But it is important to note that a falling dollar is self-correcting. For example if the dollar were to drop 50%, then a US house that previously cost 200,000 Canadian dollars, would now only cost 100,000. So investment money would begin to flow back into the country. Also US- based manufacturers get a boost. For example, a US-made widget that previously cost 100 Canadian dollars would now cost only 50. So demand for US exports surges. This increases the demand for dollars and causes the dollar to stabilize.
This is exactly what is happening in Iceland. The government refused to bail out their banks – their stock market dropped 95%, their currency dropped 60%, but they are now recovering strongly:
Until there is crisis, there will be no public support for change. But once the crisis begins, public opinion will begin to support real change and the nations will cut spending, and the economic healing can begin.
This article is part of Bob’s recent economic newsletter. For more information on this and other economic forecasts by Bob Fraser, download his economic newsletter, “Joseph Insight”. The newsletter is available for FREE download to all logged in member at www.josephinternational.org
