US National Debt Myth Busters Part II: Never Put Off Until Tomorrow What You Can Do Today

Michael McTague |

US National Debt Myth Busters Part I: Never Put Off Until Tomorrow What You Can Do Today“Never put off until tomorrow what you can do today” -- Part I

Part II picks up with more analysis on this ponderous national issue in the face of federal actions related to the budget and the deficit. Part I took up two compelling reasons that tell us the myth maintains currency: the growth of government and our rising dependency on the government.

The third reason concerns the probable cheapening of the dollar. Consider the effect on the economy of the first two issues. The society depends on government services; these services are growing rapidly and virtually impossible to cut. The cost is high and this leads to annual deficits. Interest payments on the debt grow each year, but their power to leverage the deficit is absent from public discourse.

During the recent recession, the Federal Reserve issued or purchased directly a great deal of government debt by acquiring toxic assets and then through QE I, II and III. The size of the annual interest payments owed by the government for 2012 stands at $360 billion according to Treasury Direct. (Other definitions show the expense at $220 billion.) As the debt rises, the cost of annual interest payments also rises. However, a significant problem lies hidden in the grass. Since the interest rate on government instruments remains at historic lows, interest payments have not risen sharply in recent years.

Melancholy envelopes investors suffering from yields across the bond market. Now that the economy is moving slowly toward better health, the Federal Reserve may ease itself out of the easing business (pardon the pun). Sooner or later, interest rates will tick upward. The gloom will lift from bond investors. Pension fund managers employing the standard 60/40 portfolio (60% stock, 40% bonds) will breathe a sign of relief. But the national debt will leap upward.

Suppose the interest rate on government bonds rises to 3%. It is conceivable that the annual interest on the national debt would rise to $660 billion (tripling the more conservative number shown above). Here is a sampling of published rates on one-year Treasury bills:

1963    3.03
1973     7.02
1993   3.29
2012   0.17

Maybe $660 billion is too conservative. Certainly, the extremely low interest rates of recent years should raise the hair on the back of one’s neck when you think of it in connection with the future of the national debt.

Inflation In Check

Inflation remains under control, but this may change as well in the years ahead. As the Federal Reserve backs off its policies to assist the sluggish economy, and as the economy improves under its own steam, the actions to keep interest rates down will probably fall down the list of priorities. So, interest rates will rise. This will bring some inflation and will cheapen the value of the dollar. As with the excessively low interest rates in today’s market, inflation will mask the real danger of growing debt. Today’s debt will appear modest in the wake of inflation.

To ease the debt burden, the government may shift to a different kind of financial action. The Federal Reserve’s ballooned balance sheet runs over with trillions of dollars of securities created  to stimulate the economy. At some point, this “money supply” sitting on the Federal Reserve shelf may slide into the economy. Such a massive increase in legal tender would cheapen the value of the dollar. This would ease the government’s own debt but would hurt personal savings. So, inflation and a reversal of quantitative easing will coalesce while the dollar slides.

Few pundits are discussing exactly how this would work. Imagine in a few years – as government debt and as federal deficits rise -- Goldman Sachs and other bank holding companies borrowing cheap money from the Federal Reserve in order to buy the Federal Reserve’s assets. Rather than stimulating small and medium sized businesses to hire millions of workers, this would create a whirlwind of cheap federal money flowing through bank holding companies. The sheer amount of money flowing into the economy may spur inflation while the cheap federal money would not achieve its purpose -- expanding employment. And all of this is so well-meaning.

Reason number four in support of taking this myth seriously concerns the likely effect on those who start businesses. Kindling the entrepreneurial spirit was supposed to be a goal of the stimulus package. It appears that efforts to start new businesses during the recession – aided by cheap money – proved only marginally successful. Turning the clock ahead, the outlook for business starters will probably decline.

Interest rates will soar while the government searches for more revenue to pay off its own swelling debt. That means more taxes. So, would-be entrepreneurs will face powerful challenges: high unemployment; low personal savings among consumers; existing businesses ready to pounce on new opportunities (Just ask Apple about Iphone knock offs!); higher interest rates; and rising tax levels.

In these first two articles on the myth “Never Put Off Until Tomorrow What You Can Do Today,” we looked at four compelling reasons why the myth makes sense and why our actions with regard to the national debt do not make sense. Those reasons are,

The growth of government
Our expanding dependency on the government
The probable cheapening of the dollar
Dampening the entrepreneurial spirit

In Part III, the goal is to make some sense out of where this is heading. A few words will be said about John Maynard Keynes and the ubiquitous Paul Krugman. So far, let’s agree that this intriguing myth gives us cause to think about the future.

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Michael McTague, Ph.D. is Executive Senior Vice President at Able Global Partners in New York.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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