As the issuer of the world's reserve currency, the US government hasenjoyed the benefits of low interest rates despite its inflationarypractices. When we run a trade deficit with a country like China, theyhave a strong incentive to 'recycle' the deficit back into our dollarsand Treasuries. This practice has hidden what would otherwise be muchhigher borrowing costs and much lower purchasing power for the dollar.This artificial price signal allows people like Paul Krugman to claimthat the Obama Administration's stimulus programs should be muchlarger. Because our yawning fiscal deficits have not driven bondyields significantly higher, he sees no reason to curtail spending.Krugman wants to spend like its World War III, and then has the nerveto call those worried about the budget mindless zombies!
Krugman is just one partisan Democrat shouting at mirrors, but the misunderstanding has struck theright-wing as well. Last week, in a debate with me on CNBC's TheKudlow Report, Brian Wesbury, Chief Economist of First Trust Advisorsand writer for The American Spectator, claimed that our $9.3 trillionnational debt is of little consequence because our GDP is a fargreater. However, he failed to note that our $14.7 trillion of GDPonly yields about $2.2 trillion in revenue for the Treasury. To fullyaccess that entire GDP, the government would have to raise all taxbrackets to 100% without producing any reduction in output or decreasein revenue. This is, of course, preposterous. As was demonstrated inthe 1970s, even small increases in marginal tax rates have asubstantial negative impact on output. A healthier appraisal wouldcenter on the fact that our publicly traded debt is now 422% of ourannual tax revenue.
Wesbury did mention that if the government could not raise revenue to pay off the bonds, it could simply monetizethe debt with few significant consequences. Apparently, paying backone's creditors in worthless paper is not technically "default" to aneconomist.
So neither Krugman nor Wesbury, both intelligent, highly educated economists, see our current courseleading to imminent crisis. Unfortunately, both have been led astrayby the low debt service ratio which has masked our economy'sunderlying insolvency. To see through the haze, you have to look atthe numbers behind this so-called "deleveraging consumer" and thenlook at the debt of the nation.
The data point most utilized by those who espouse the idea of a healthy consumer is the household debt serviceratio (DSR), a metric that relates debt payments to disposablepersonal income. This figure peaked at 13.96% in the third quarter of2007; it has since dropped by 15%, to 11.89%. It is hard to see thisas a significant amount of deleveraging, especially when looking atlonger term trends. But it gets worse! Most of that modest decline issimply a function of lower interest rates, which have made debt easierto bear. Total household debt has gone down much less. This figurepeaked at $13.92 trillion in Q1 2008, and has since declined only 3.5%to $13.42 trillion. How's that for deleveraging?!
It's also worth noting that back in the first quarter of 2008, most homeowners were sitting on a pile of homeequity to offset that debt. Today, most of the equity has vanished,yet the debt still remains.
When looking at the national debt, the situation is even more depressing. At the end of 2006, total debt heldby the public was $4.9 trillion. According to the Treasury Department,the average interest rate paid on that debt was 4.9%. Therefore, theannualized interest payment at that time was $240 billion. At the endof 2010, our publicly traded debt has increased to $9.3 trillion, butthe average interest rate on that debt has plummeted to just 2.3%. So,despite an 87% increase in debt in just a 4-year time span, theannualized debt service payment actually fell 11% to $213 billion.Krugman and Wesbury look at this and see progress.
Meanwhile, the average maturity on our debt has declined to 5.5 years. Compare that with the UK's gilts, whichaverage about 14 years, or even to Greece's bonds, which average about8 years. Falling interest rates and reduced durations have merelygiven the illusion of solvency to the US as compared to these otherailing sovereigns.
By 2015, our publicly traded debt is projected to be at least $15 trillion. Even if interest rates simplyrevert to their average level - not a stretch, given surging commodityprices and endless Fed money printing - the debt service expense couldeasily reach over $1 trillion, or about 50% of all federal revenuecollected today. Just imagine what would happen if rates were to riseto the level of Greece, nearly 12% on a 10-year note, as opposed toour current 10-year yield of just 3.5%. I bet Athens, Georgia wouldn'tlook much better than its namesake. Don't forget: as interest ratesrise, GDP growth slows, sending the debt-to-GDP ratio even higher.
Earlier this year, it wasn't the nominal level of debt that suddenly sent euroland into insolvency, but rathera spike in debt service payments. Right now, the US national debt isthe biggest subprime ARM of all time. Much like homeowners who thoughtthey could afford a mortgage that was 10 times their annual incomes,Messrs. Krugman and Wesbury are blinded by deceptively low currentrates of interest. These ostriches won't poke their heads up to seethe writing on the wall: low rates and quantitative easing cannotcoexist for long. As rates continue to rise, the reality of USinsolvency will be revealed.
Michael Pento is SeniorEconomist and Vice President of Managed Products at Euro Pacific capital,Inc.
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