In our previous posts in this series, we\u2019ve established that the United States government is spending about $1 trillion more than they get in revenues, has accumulated somewhere around $20 trillion in debt of various kinds, and has unfunded liabilities so high that they would need perhaps as much as $100 trillion in the bank right now to cover the future expense.<\/p>\n
Why is this debt a serious problem?<\/p>\n
It is a problem for the same reason that high personal debt is a problem. Debt has to be repaid, and while it is being repaid, it has to be serviced \u2013 meaning, the interest has to be paid. The higher the debt goes, the higher the cost to service it goes, and the higher the cost to repay it goes.<\/p>\n
How much interest did the US government pay on its debt in 2012? Close to $360 billion, according to the US treasury. Let\u2019s go back to our fictional example of Joe, who makes $25,000 a year, spends $35,000 a year, owes $200,000 in borrowed money, and needs $1 million in the bank to keep his promise to his parents to support their retirement. The government\u2019s debt interest scaled to Joe\u2019s world represents a payment of $3,600 a year, or about 14% of what Joe makes in a year. While this doesn\u2019t sound too bad, it\u2019s only this low a payment because Joe has borrowed his money at a very low interest rate: from 1% to 2.5% depending on the lender. Also, Joe is paying interest only and not paying any principal, so the debt is only being serviced and not repaid. To approximate Joe\u2019s $3,600 a year in payments, we\u2019d use a blended interest rate of 1.8%: $200,000 times 1.8% is $3,600.<\/p>\n
Credit in the world is a limited commodity, at least until governments start printing fiat currency*. What happens to any limited commodity as it is bought up? It gets more expensive. In addition, as the fiscal weakness of the United States becomes more and more obvious, lenders see the increased risk, so the cost of credit rises. The cost of credit is expressed in its terms, which usually means the interest rate. Let\u2019s say Joe goes on another five years without changing his ways. At the start he\u2019s spending $10,000 a year more than he makes, and now, his parents\u2019 expenses add somewhere around $13,333 a year. He has to service the debt as it rises, so his deficit rises and debt grows from $200,000 to $340,000. The extra $140,000 would have made his annual debt payment grow to $6,120 if he had been able to borrow at the original interest rates, but Joe\u2019s creditors are getting wary of his debt and income level, and have now raised his rates to 3.6% on the newly borrowed funds \u2013 still a fairly low rate, but now, Joe\u2019s annual debt service costs him $8,640. This is 2.4 times what it used to cost, and raises his annual spending from $35,000 to about $40,000 a year. His debt service has gone from about 14% of what he makes to more than 34%. If Joe continues on in this way, eventually the cost of servicing his debt will be higher than what he makes. While Joe might succeed using tricks such as borrowing more money to pay the existing debt\u2019s interest, eventually he will become insolvent by defaulting on his debt service. Now let\u2019s look at the option of Joe attempting to repay his debt before this happens. What might Joe do, given his $10,000 overspending, $200,000 in debt at 1.8% annual interest, and $1 million in unfunded liabilities which averages about $13,333 a year in additional spending?<\/p>\n So, to maintain the same life he had, and meet all of his obligations, Joe would need to increase his income from $25,000 a year to $53,365 \u2013 more than double what he makes now. Since this is unlikely to be possible, he\u2019s going to have to figure out some combination increasing income, not meeting on his obligations, and\/or extreme cost-cutting in his lifestyle to make the numbers work. Worst of all, this is the picture now<\/i>. If Joe goes on 5 years and owes $340,000 instead of $200,000, with a higher blended interest rate, the picture is far more bleak. The annual payment on the additional $140,000 at 3.6% would be $7,638 \u2013 meaning just to make his debt payment and obligations would cost Joe $29,603 a year, more than he makes without even spending a penny on his rent or other bills.<\/p>\n If we scale all of these numbers up to our government\u2019s revenue, spending, and debt, it means that just like with Joe\u2019s income, taxes on individuals and businesses would have to more than double for the government to have the revenue they would need to pay off our debt in 30 years and meet their obligations \u2013 except that history has shown that raising tax rates does not significantly raise the amount of taxes collected*. So there would have to be some combination of tax increases, spending cuts, and\/or lowering of the cost of obligations like Social Security and Medicare would be required \u2013 often referred to as austerity measures — and again, worst of all, this would have to happen right now<\/i>. Every day we don\u2019t do these things means we accumulate up more debt, and the choices become more and more painful. If our government gets into debt deeply enough, just as with Joe and his fictional financial woes, insolvency will become unavoidable. I believe it already is unavoidable.<\/b><\/p>\n In the next post we will examine the possible effects of government insolvency.<\/p>\n","protected":false},"excerpt":{"rendered":" In our previous posts in this series, we\u2019ve established that the United States government is spending about $1 trillion more than they get in revenues, has accumulated somewhere around $20 trillion in debt of various kinds, and has unfunded liabilities so high that they would need perhaps as much as $100 trillion in the bank […]<\/a><\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[2],"tags":[],"class_list":["post-111","post","type-post","status-publish","format-standard","hentry","category-financial","category-2-id","post-seq-1","post-parity-odd","meta-position-corners","fix"],"_links":{"self":[{"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/posts\/111","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=111"}],"version-history":[{"count":8,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/posts\/111\/revisions"}],"predecessor-version":[{"id":125,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=\/wp\/v2\/posts\/111\/revisions\/125"}],"wp:attachment":[{"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=111"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=111"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/thelitfuse.com\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=111"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
* Fiat currency means the government pays their bills by printing up new money that isn\u2019t backed by anything. Printing fiat currency in large amounts causes existing money to lose value, triggers severe inflation, and often causes a currency crisis. This will be covered in a later post.<\/span><\/p>\n\n
See "Hauser’s Law" reference in post on Progressive Taxation<\/a> for more information.<\/span><\/p>\n