‘No Way Out’ of Debt Trap

by Veronique de Rugy

This is a depressing but spot on interview with Bill Gross, founder of PIMCO, about our debt situation. He concludes that we should brace ourselves for higher interest rates in the very near future.

How much higher? Under CBO’s baseline, interest rates go from 3.2 percent in 2011 to 5.4 percent in 2021; the president’s budget has roughly the same projections. (This Wall Street Journal chart shows the amount of money that will go to servicing our debt if these assumptions are correct.)

But on February 24, the CBO responded to Rep. Paul Ryan’s request for CBO analysis of three different interest-rate scenarios. These three scenarios are:

1. The rate on 10-year Treasury notes issued in calendar year 2011 would average 3.8 percent (3.5 percent in fiscal year 2011), and it and all other Treasury interest rates would rise in the future to approximately their average levels over the 1991–2000 period.

This means that rates would go from 3.5 percent in 2011 to 6.6 percent in 2021.

2. The rate on 10-year Treasury notes issued in calendar year 2011 would average 3.8 percent (3.5 percent in fiscal year 2011), and it and all other Treasury interest rates would rise in the future to approximately their average levels over the 1981–1990 period.

This means rates would climb to 10.5 percent in 2021.

3. Interest rates would follow a path that is consistent with the average of the10 highest projections shown in the October 2010 and February 2011 releases of Blue Chip Economic Indicators.

This means rates would climb to 6.2 percent in 2021.

The result:

Under all three scenarios, interest costs would be higher than CBO estimated in its January baseline projections (see Table 2). The effects would be minimal for 2011. Between 2012 and 2021, though, interest payments under scenarios 1 and 3 would be about $1.1 trillion and $1.2 trillion higher, respectively, and under scenario 2, interest payments would be $5.4 trillion higher. The cumulative deficit and debt held by the public at the end of the 10-year period would rise by similar amounts. A small portion of the additional interest payments would be offset in most years by larger remittances by the Federal Reserve System on its earnings from holding Treasury securities, which are shown as added revenues in Table 2. The estimates in Table 2 do not account for possible effects on the deficit and debt of other differences in economic conditions that might accompany higher interest rates.

The last sentence is important, because it basically says that these projections, which show an explosion in the amount of money needed to service our debt, underestimate the problem, since any decrease in economic growth resulting from higher interest rates — or any other cause — is not accounted for. Bottom line: This could be really bad.