Commentary of economists Rogoff and Reinhart are often used as points of reference concerning thresholds of debt levels that trigger a debt trap. After the publication of their book on the topic, there were rebuttals from the debt-doesn’t-really-matter crowd. I did a cursory reading of these counterpoints and can only say that their arguments were circular, anal, counter-intuitive, and not even worth discussion. I really try to keep an open mind, but sometimes in life you come across people you know are BS’ing you. You know it because their lips are moving.
For those who argue it does matter, one number being tossed around is the level at which debt service equals 30 percent of tax revenues. Once interest payments take 30% of tax revenues, a country has an out of control debt trap issue. When you think clearly about it, this just makes sense, as the ability to dodge, weave and defer is pretty much removed, as is the logic that it will be repaid in a low-risk manner. The world is going to be a different place when the US is perceived to be in a debt trap.
I suspect the problem will rear its ugly head well before this 30% number is hit, as markets start discounting the trajectory by hiking interest rates because of poor credit quality and/or inflation (or more accurately stranguflation). Naturally that question should be asked in terms of the recent and sudden uptick in Treasury note and bond rates that appeared strongly correlated to the latest round of tax “stimulus” and handouts, and the “unexpected” reaction to QE2. The latter is nothing more than a brazen, dangerous gamble to monetize the debt. Sure the BS crowd is claiming economic growth is the causa proxima, but that feels like utter nonsense. Could it be that the markets at long last are anticipating a very bad result from QE2 and even more Gumnut largess?
During calender year 2010, the Gumnut will collect $2.05 trillion in taxes. With the tax cuts and extensions likely coming, this variable may well track lower. Sometime shortly after the New Year, debt outstanding will hit $14 trillion (can track here) heading higher at a clip of about $100 billion per month. Interest paid on national debt for the FY 2010, which ended in September, was $414 billion or about 20% of tax revenues. That interest was against debt that was averaging about $13 trillion.
In addition, the interest cost to the Treasury as of November was 3%. $1.8 trillion in Treasuries matures in 2011. The big majority is in T-Bills, where the average interest cost is a mere 0.20%. That short-term debt maturing variable will move higher as more Treasury bills are sold at each successive auction. We can see from the chart above that those easy, ultra-low interest pickings have been reversed some. Both the interest cost and interest paid can be tracked at the Treasury site.
Taking those variables into account, it is apparent that a trajectory toward 30% looks very likely. Each step along the way will add to the stress on credit quality and interest rate cost. The latter is the key variable because a move of only one percent in interest rate cost takes the debt service percent up quickly. For example, against a debt of $15 trillion, 4% cost of money equals $600 billion in interest expense. If tax revenues are still running about $2 trillion, then you have your 30% debt trap thresholds in spades.
This article originally appeared in Russ's blog Winter (Economic and Market) Watch and Russ Winter's Actionable, a premium service that tracks Russ's trading strategy and tactics and his actual trades.
