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National Debt Approaching Terminal Velocity
In an article that was published recently in USA Today entitled, “rising national debt maybe next economic crisis”, the newspaper brings up a very interesting scenario. What if the United States was crushed by its debt load? How would we be able to sustain the current social services that are being provided? How would we be able to continue to pay the amount of money that we do pay for defense, Medicare and Social Security? In short, how would we be able to sustain our current standard of living?
These are all quite interesting questions and ones we need to be asking now. In taking a look at the current state of affairs, we see that there is a dramatically rising national debt level. This debt is composed not only of domestic debt holders, it is also debt owed to external creditors. The amount of debt is currently somewhere around $11.4 trillion. Assuming the interest rates that the government pays (which is currently running somewhere around 3 1/2% on a 10 year U.S. Treasury bond) continue, that would imply that a significant amount of interest is getting paid out annually. If we did the calculation based on the current debt of $11.4 trillion, with a 3 1/2% interest rate, we would see that just servicing the debt requires billions upon billions of dollars every year in interest payments.
Currently the United States, in being a reserve currency of the world, enjoys several fringe benefits. The first of these benefits is its ability to freely borrow money from the rest the world at what would be considered discounted interest rates. What is interesting to note is that the role of the US dollar as a reserve currency has slowly and consistently declined across the world in the last decade. In about 2001 it was estimated that the US dollar represented about 64% of reserve currency holdings worldwide. Fast forward to where we are today and that number is materially less.
So what would happen if interest rates went up? Let's use a hypothetical example. Let’s just round of the amount of debt the US government has to $12 trillion. Although this is not where it is at currently, it is fast approaching this amount. Assume also that interest rates currently are 4% for the sake of easy mathematics. That would imply that roughly $480 billion is being spent every year to finance the debt of this country. Keep in mind also that the US government's total annual revenue is somewhere around $2.7 trillion each year. This assumes there is not a precipitous fall in revenue as a result of a recession or depression. Based on that calculation and based on the fact that we’re adding a significant amount of debt to the financial books of this country, it is now plausible to look at the possibility of default for the United States.
How do you ask that is possible? Well let's go through the calculations from that same scenario that we talked about earlier of $12 trillion in debt and a 4% interest rate and see what happens if the United States government has to pay market interest rates. While that $12 trillion of debt is still there. Interest rates are closer to 7%. That would imply that the amount of money being spent on interest has just gone up dramatically. That means that instead of $480 billion per year on interest, we’re now looking at somewhere around $840 billion per year. This would represent a significant chunk of the overall revenue of the government. Keep in mind also that for every billion dollars of interest expense incurred, it is money that is not available for government expenditures (like social security, defense, etc.).
What would happen if we return to the inflation levels that the country witnessed in the 1970s? Back then, interest rates got up to well over 12%. What would happen then? Well, assuming again a steady-state the budget deficit, we would see well over 50% of the government receipts being spent on interest payments alone.
This is clearly not something that is sustainable. What is worse is that the government is not in fiscal stability. We are still spending dramatically more money that we are taking it. That budget deficit of $11.4 trillion is growing by the day. How much longer can we continue to do deficit spending before we ultimately have to pay the price? We may find out sooner than we realize. | 
