By Peter Schiff
As we head toward the end of the year, the media’s
fixation with the congressionally imposed “fiscal cliff” will reach a fever
pitch and no doubt become a major factor in the presidential campaign. The
danger is supposed to arise from the simultaneous implementation of $2 trillion
in automatic spending “cuts” (in reality, just reductions in the rate by which
federal spending increases) and the expiration of the George W. Bush-era tax
rates. Most economists fear that higher taxes and slower increases in federal
spending will combine to send us back into recession. Despite the
hand-wringing, it is certain that the lame-duck Congress will slap together a late-December, last-minute, can-kicking
compromise that will buy time at the expense of long-term solvency. Any success
in wriggling out of this particular budgetary straitjacket will just make it
more certain that we head straight for another, larger, fiscal cliff that is
hiding in plain sight.
As it is constructed currently, the U.S. budget will
be completely and thoroughly upended when interest rates approach levels that
would be considered normal by historical standards. A mere 5 percent rate
portends a clear and present danger to the budgetary priories of the United
States.
The current national debt is about $16 trillion. This
is just the funded portion — the unfunded liabilities of the Treasury, such as
Social Security and Medicare, and off-budget items, such as guaranteed mortgages and student loans,
loom much larger. Our recent era of unprecedented fiscal irresponsibility means
we are throwing an additional $1 trillion or more on the pile every year. The
only reason this staggering debt load hasn’t crushed us already is that the
Treasury has been able to service it through historically low interest rates
(now below 2 percent). These easy terms keep debt-service payments to a
relatively manageable $300 billion per year.
On the current trajectory, the national debt likely
will hit $20 trillion in a few years. If, by that time, interest rates were to
return to 5 percent (a low rate by postwar standards) interest payments on the
debt could run around $1 trillion per year. Such a sum would represent almost
40 percent of total current federal revenues and likely would constitute the
single largest line item in the federal budget. A balance sheet so constructed
would create an immediate fiscal crisis in the United States.
In addition to making the debt service unmanageable, a
return to normal rates of interest would depress the kind of low-rate-dependent
economic activity that characterizes our current economy. A slowing economy
would cut down on tax revenue and trigger increased government spending to
beleaguered public sectors. Higher rates on government debt also would push up
mortgage rates, thereby putting renewed downward pressure on home prices and
perhaps leading to another large wave of foreclosures. (My guess is that losses
on government-insured mortgages alone could add several hundred billion dollars
more to annual budget deficits.) When all of these factors are taken into
account, I think annual deficits could quickly approach, and then exceed, $3
trillion. This would double the amount of debt we need to sell annually.
Currently, foreign creditors buy more than half of all
U.S. debt issuance. Most of these purchases are motivated by political reasons
that are subject to change. The buyers, who legitimately can be described as
“investors,” extend credit to the United States at such generous terms largely
because of America’s size, power and perceived economic unassailability. If
those perceptions change, 5 percent could quickly become a floor, not a
ceiling, for interest rates. Given that America’s balance sheet bears more than
a casual resemblance to those of both Spain and Italy, it should not be radical
to assume that one day we will be asked to pay the same amount as they do for
the money we borrow. The brutal truth is that 6 percent or 7 percent interest
rates will force the government to either slash federal spending across the
board (including cuts to politically sensitive entitlements), raise middle-class
taxes significantly, default on the debt, or hit everyone with the sustained
impact of high inflation. Now that’s a real fiscal cliff.
By foolishly borrowing so heavily when interest rates
are low, our government is driving us toward this cliff with its eyes firmly
glued to the rearview mirror. Most economists downplay debt-servicing concerns
with assertions that we have entered a new era of permanently low interest
rates. This is a dangerously naive idea.
For years, I warned that the bursting of the real
estate bubble would trigger a financial crisis. My warnings routinely were
ignored based on the near-universal assumption that real estate prices would
never fall. That was wrong. My warnings about the real fiscal cliff also are
being ignored because of a similarly false premise that interest rates will
never rise. However, if history can be a guide, we should view the current
period of ultralow rates as the exception rather than the rule.
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