U.S. debt crisis might be on fast track
Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021.
– Private interest rates will rise as federal borrowing competes for saving that might otherwise finance private investment.
– In addition, yields could rise if there is growing risk associated with current fiscal policy. If such risk is systemic, it raises yields generally. If it reflects a growing probability of sovereign default, it raises Treasury yields relative to private yields.
– Rising rates would be a precursor to something worse: a full-fledged fiscal crisis with further sharp increases in yields, declines in stock prices, and a plummeting dollar.
This is bad. Really bad. The official budget forecasts ones typically hears about in the media are from the Congressional Budget Office. And those forecasts assume Uncle Same can borrow at low interest rates, like, forever. The super-cautious CBO baseline predicts the U.S. government will add an additional $6.8 trillion in debt over the next decade, bringing cumulative debt held by the public to $18.2 trillion. Debt as a share of the economy would be 76.7 percent. The forecast also assumes short-term interest rates average 3.3 percent, long-term 4.8 percent.
But MA thinks long rates will hit 9 percent. This would cause U.S. indebtedness to explode. The CBO, at the request of Rep. Paul Ryan, recently looked at how various interest rate scenarios would affect U.S. debt (chart and graph via the Committee for a Responsible Federal Budget):
Note the scenarios that has interest rates at close to 9 percent. It would add an additional $5 trillion to the national debt by 2021. That would push the U.S. debt-to-GDP ratio to an alarming 98 percent of GDP.
But those calculations tend to understate the problem because they are based on the CBO’s baseline forecast. Its “alternative fiscal scenario” – which many budgeteers think is a more accurate – assumes debt-to-GDP will already be 101 percent in 2021.
But again, this is assuming low interest rates. The MA scenario could push that level even higher. And again, this also assumes all that debt would not effect economic growth. Here is how the CBO says various economic variables affects its forecasts
CBO estimated that 1 percent higher interest rates each year could increase deficits by $1.3 trillion over ten years. CBO also estimated a few other “rules of thumb” to show how changes in inflation and economic growth have significant impacts on budget forecasts. The projections show that lower economic growth of just 0.1 percentage point each year could increase deficits by $310 billion over ten years, while 1 percentage point higher inflation each year could add almost $900 billion to deficits.
Turns out, the CBO looked at how at the deluge of debt from its “alternative fiscal scenario” would impact the economy (and, in turn, total indebtedness). The results are absolutely frightening:
Of course, the U.S. would have a debt crisis long before we hit that 250 percent of GDP level. And if MA is right, the crisis might come sooner rather than later.