Tuesday, July 26, 2011

The Road To Hell Directly Before Us

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The death spiral
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Here's how it all can come apart, and why Congress - and Obama - are both on the wrong track.

Note this story from Bloomberg:

Political wrangling over a plan to reduce the deficit may cost the U.S. its AAA rating, adding $100 billion a year to government costs while dragging down economic growth, according to Wall Street bond dealers.

A U.S. credit-rating cut would likely raise the nation’s borrowing costs by increasing Treasury yields by 60 to 70 basis points over the “medium term,” JPMorgan Chase & Co.’s Terry Belton said today on a conference call hosted by the Securities Industry and Financial Markets Association.

But that's just the start, you see.

Right now rates are at historic lows. So let's presume that the economy "improves"; if that happens then rates go up. In fact, there was a hearing this afternoon in the House Banking Subcommittee talking about exactly that.

Here's the current Treasury MTS; it shows total interest on the public debt last year was $355 billion, and this year thus far is $386 billion. This implies (on a grossed-up 9/12ths basis) that the blended interest rate on the debt is running about 3%.

Here's the problem, in short: Rates have nowhere to go but up.

So is 70 basis points "realistic"? No. If the economy improves, they'll go up double that or more just on their own on the short end. Then you get to add this "penalty" from the downgrade.

We have the government claiming they will "cut" about $1 trillion in real spending (the rest is gimmicks - the wind-down of the wars that were going to happen anyway) over the next ten years.

But if the economy improves the increased cost of the interest on the existing debt will be double that over the same ten years, and if we get downgraded you can double that again!

Each 100 basis points on $15 trillion in debt is $150 billion a year - every year - and the CBO says we'll have $25 trillion in debt by 2020.

At a 4% blended interest rate this load on that $25 trillion will come to $1 trillion in interest annually - just 1 percent higher in interest than we're paying now!

We will not get to 2020 folks; this is, in fact, exactly how the death spiral happens.

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