The yield on Italy’s 10-year bond is up by about 100 basis points from its 2018 low. Meanwhile, its government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, forcing it to borrow even more money, and so on until this “interest rate death spiral” becomes fatal.
It would already be fatal, if not for the European Central Bank’s willingness to buy Italy’s bonds at extremely favorable prices (i.e., very low interest rates). But now the ECB is promising to stop doing that, which leaves Italy in the early stages of a very negative feedback loop.
Not our problem, you say? Italy is irrelevant to everyone including most Italians, so its imminent financial crisis is no more important than Venezuela’s.
Fair enough. Let’s move closer to home and start the story over:
The yield on US 10-year Treasury paper is up almost 100 basis points since last September. Meanwhile, the government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, which means it has to borrow even more money at higher interest rates, and so on until this “interest rate death spiral” becomes fatal.
It would already be fatal if not for the Federal Reserve’s willingness to buy Treasury bonds at extremely favorable prices (i.e., very low interest rates). But now the Fed is promising to stop doing that, which leaves the US in the early stages of a very negative feedback loop.
Here’s what the US government’s interest payments would be under different average interest rates:
Note that the highest rate used in this table – 6% – is about average for the two decades prior to 2000. So it only seems extreme in today’s era of monetary experimentation. We’ll get back there, one of these days.
Except that we won’t. An annual interest bill of 1+ trillion dollars would send the deficit – which is projected exceed a trillion without a meaningful rise in interest rates – above $2 trillion. And – since new interest will accrue on each year’s new borrowing – the current $21 trillion US government debt would grow by around 10% a year in this scenario, shifting the process of higher rates producing higher deficits into overdrive. This impossible-to-hide acceleration will in turn produce extreme responses from governments and/or markets, including but not limited to spiking inflation, plunging bond prices, capital controls, martial law and a global monetary reset.
Italy will probably get there first, which allows Americans to view our future by looking across the Atlantic. So you see it does matter.
And remember, this scenario involves only central government debt, which is cumulatively dwarfed by private sector debts, state and local unfunded pension liabilities, emerging market external dollar debts, and bank derivatives. And all of these things are vulnerable, one way or another, to rising interest rates, which means the interest rate death spiral, when it kicks into high gear, will be something for the history books.
For arguments sake lets assume that the economy is growing at 4.1%.
1) US GDP is $18.5 Trillion.
2) 4.1% of $18.5 Trillion is $750 Billion.
3) The Federal government borrowed $1 Trillion over the last year.
In other words without that $1 Trillion dollar budget deficit we’d be in a recession right now.
When interest rates surge we’re done.
Any talk by “Socialists” of massive new entitlements like free college, housing or guaranteed government jobs is comedy. We’re going broke with CURRENT entitlements.
If during the next financial crisis central banks have to stabilise the system, they may opt for negative interest rates, because that’s where the equilibrium is.
There is too much capital and too much debt to justify higher interest rates. So, if interest rates go negative, it would be time to ban interest alltogether.
Because who wants to borrow to Italy at zero interest if it is on a debt death spiral? Italy has to fix its finances then.
So, ban interest for financial sanity. There is no need for more debt.
The EU is telling Italy to take more rapists or they will collapse the Italian economy.
Yes, but the Government borrows most of its money from the Fed. Thus paying interest to the Fed. At the end of every year, the fed returns all interest back to the Government, thus paying zero effective interest rate no matter if it is borrowed at 2 pct or 20 pct. Japan is waaaay ahead of us on this front, maybe 10-15 years. So, I do not see the imminent collapse.
Tom, that’s true as long as the Fed keeps buying new Treasuries and holding onto what it currently has. But last year it stopped buying and started letting its portfolio shrink as the bonds mature. That puts taxpayers back on the hook for government interest costs. So either the Fed ends QT and goes back to QE, or the interest rate death spiral takes hold.
Agreed. But you know they will be back as soon as things get shaky. Look at Japan.
The US trade deficit is roughly 3% of GDP.
Japan’s trade surplus is 4% of GDP.
If we want to keep interest rates at 0% without inflation we had better start running a huge trade surplus. Simply owning the reserve currency didn’t protect us from inflation in the 60s or 70s.
Haven’t looked up the data, but I wouldn’t be surprised if we were running a trade surplus in the 60’s and maybe 70’s also, so not exactly sure what your point is.
I don’t believe Japanification is in our future. Our economy/currency can’t handle 0% interest rates for such an extended period. Not to mention that pension funds can’t handle low interest rates much longer. In my city the Police/Fire pension fund is roughly 45% funded. One deep recession and it’s lights out. To balance our trade, increase savings and rescue the pension industry rates have to go higher. Way higher.
Rubino’s not interested in facts.