Interesting remarks by U.S. Chamber of Commerce’s Executive Vice President of Government Affairs

Bruce Josten, executive vice president for Government Affairs U.S. Chamber of CommerceNote: “In its most recent forecast, CBO projects that over the next 10 years the outside debt will grow to $19.9 trillion, and the inside debt will grow to over $6.1 trillion. With the economy expected to grow to about $26 trillion, the overall debt ratio would still be in excess of 100% and rising 10 years from now.  The current interest cost on the debt in 2012 was $360 billion—just over $222 billion on the outside debt and $137 billion on debt held in government trust accounts. The latest CBO forecast projects interest cost on the outside debt to rise to over $857 billion by 2023. Net interest on just the outside debt is projected to grow from 6.3% of the total deficit in fiscal year 2013 to over 14% of the deficit in 2023. This increase in the interest portion of the deficit is even more damning when one considers that the size of the deficit is projected to grow from $3.6 trillion to $5.9 trillion over that period.”The Exchange Money is still flowing...

“CBO doesn’t forecast the growth in interest cost of inside debt, but a rough approximation using similar rate assumptions would show that the interest on the inside debt would rise to over $300 billion. Together, interest on the government debt would be over $1.1 trillion annually or over 4% of GDP.  A number like 4% of GDP may not shock anyone, since back in the 1980s and early 1990s we had gross interest ratios that high. Back then, however, the ratio was that high because of historically high interest rates, but our debt ratio was much lower (about 60%) than it is today. Recently, CBO was asked what would happen if we were to experience such high rates today? Its answer is shocking.  If interest rates went back to the average of the 1980s—about 8.8% at the short end of the maturity spectrum and 10.8% at the long end—the interest cost on the outside debt alone would rise dramatically, reaching over $350 billion in just four years and adding almost $1.4 trillion per year in 2023. The cumulative effect would be over $6 trillion.” 

Disinterest With Interest

CBOPicture*****************************

Freeenterprise.com

by Dr. Marty Regalia

Although it cannot be verified, financier Baron Rothschild is credited with saying that compound interest is the eighth wonder of the world. Most of us are at least vaguely familiar with the concept by which our savings earn interest, which is then added to the principal so that in successive periods we earn interest on our interest—we earn compound interest. If you put away $100 at 10% interest, you would earn $10 the first year, $11 the second year, $12.10 the third year, and so on. The $100 in principal would double in a little over seven years. Mathematicians would quickly recognize this phenomenon as growth theory or exponential growth theory.

What many people don’t seem to be as knowledgeable about is the flip side of the coin, that is, what happens when we borrow money and don’t pay it back such that the interest is added to the principal and in successive years we actually owe more than the original amount we borrowed. We must pay interest on our interest. In the mortgage industry, this is called negative amortization, and it is generally frowned upon, especially when borrowers find its description buried deep in the small print of the mortgage contract.

What even fewer people seem to recognize is that our government engages in negative amortization every single day, and in the end, it is us, the American taxpayer, who foots the bill. Every year, our government owes interest on its accumulated debt, and since the government generally runs a deficit on the non-interest part of the budget (i.e., a primary budget deficit), the interest owed this year is added to the current deficit and accumulates as next year’s debt. Next year, the debt level is higher and we pay even more in interest, which adds to next year’s deficit and debt and so forth.

Size of Our Debt

As long as the overall level of debt is relatively small and interest rates are relatively low, the interest numbers are swamped by other spending figures and the problem goes largely unnoticed. But a funny thing happens when the size of our debt gets large relative to the size of the economy and the interest rates owed on that debt rise. The debt service, the interest payments on our debt, become a bigger and bigger share of our annual deficit and begin to accumulate as larger additions to our level of debt. At some point, it becomes beyond our ability to service our debt—let alone repay the principal. At that point, our deficit is out of control and even a truly draconian combination of spending cuts and tax increases may not be able to rectify the situation. At that point, we have become Greece or Cyprus.

Now, the United States may not be quite that bad yet. But a clear sign that we are approaching the danger zone is when our debt relative to the size of the economy exceeds 100% and when the interest on the debt starts to grow as a percentage of our total deficit.

Our Fiscal Health

So let’s take a hard look at our current fiscal situation. At the end of fiscal year 2012, the U.S. economy was about $15.5 trillion. The total debt of the U.S. government was about $16 trillion—$11.3 trillion was debt held by the public or outside debt, and roughly $4.7 trillion was in inside debt, that is, debt held in government accounts, such as the Social Security Trust Fund. Thus, the total debt to GDP ratio was 103%. Now, some would have you believe that the debt in the internal accounts is debt that we owe to ourselves and therefore is not a problem. That is simply not true. When Social Security obligations exceed their current cash flow from payroll tax revenue, the trust fund must call on the Treasury to redeem the debt held in the trust fund. However, with the government in a perennial deficit position, the only way that the Treasury will be able to get the needed funds to redeem the inside debt is to issue more outside debt. The inside debt becomes outside debt when the trust funds need to write checks to the beneficiaries.

In its most recent forecast, CBO projects that over the next 10 years the outside debt will grow to $19.9 trillion, and the inside debt will grow to over $6.1 trillion. With the economy expected to grow to about $26 trillion, the overall debt ratio would still be in excess of 100% and rising 10 years from now.

The current interest cost on the debt in 2012 was $360 billion—just over $222 billion on the outside debt and $137 billion on debt held in government trust accounts. The latest CBO forecast projects interest cost on the outside debt to rise to over $857 billion by 2023. Net interest on just the outside debt is projected to grow from 6.3% of the total deficit in fiscal year 2013 to over 14% of the deficit in 2023. This increase in the interest portion of the deficit is even more damning when one considers that the size of the deficit is projected to grow from $3.6 trillion to $5.9 trillion over that period.

CBO doesn’t forecast the growth in interest cost of inside debt, but a rough approximation using similar rate assumptions would show that the interest on the inside debt would rise to over $300 billion. Together, interest on the government debt would be over $1.1 trillion annually or over 4% of GDP.

Impact of Higher Interest Rates

A number like 4% of GDP may not shock anyone, since back in the 1980s and early 1990s we had gross interest ratios that high. Back then, however, the ratio was that high because of historically high interest rates, but our debt ratio was much lower (about 60%) than it is today. Recently, CBO was asked what would happen if we were to experience such high rates today? Its answer is shocking.

If interest rates went back to the average of the 1980s—about 8.8% at the short end of the maturity spectrum and 10.8% at the long end—the interest cost on the outside debt alone would rise dramatically, reaching over $350 billion in just four years and adding almost $1.4 trillion per year in 2023. The cumulative effect would be over $6 trillion.

Because the 1980s were unusual times, CBO ran the numbers to see what would happen if rates rose to their 1990s average—about 4.9% at the short end and 6.7% at the longer end. At these more modest rates, the interest cost on the outside debt only would add over $250 billion per year by the end of the 10-year period. The cumulative impact would add over $1.4 trillion to the level of outside debt. Just the effect on the outside debt would add over 5.5 percentage points to the debt to GDP ratio.

The bottom line is this. Our debt levels are way too high, our deficit is way too high, and the existing low interest rates are masking the danger. If interest rates rise— and remember they are at rock-bottom levels historically—our deficits and debt levels will rocket out of control. The Fed’s aggressive monetary policy is currently keeping rates low but at the risk of future inflation and higher interest rates.

We need to cut government spending, especially entitlement spending; lower out deficit; and stabilize and then reduce our level of debt. We need to start the process now. In the meantime, praying that interest rates don’t rise may be a
good idea.

By:
R. Bruce Josten

Executive Vice President, Government Affairs
U.S. Chamber of Commerce
1615 H Street NW
Washington, DC  20062
202.463.5310
bjosten@uschamber.com

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