Nov 26 2012
Rejection of U.S. debt leads to interest rate spike
While Washington is preoccupied with the so-called fiscal cliff, little attention has been given to the fiscal avalanche that will occur if we continue down an unsustainable, long-term path, causing markets to turn sour on U.S. debt and leading to a spike in interest rates.
Such a eurolike crisis would make the fiscal cliff look like a dip in the road. Unlike driving off a cliff, which you can see coming and make last-minute adjustments to avert, we cannot predict with any reasonable certainty when the avalanche will break. If it does, there will be little anyone can do to prevent its devastating effects.
No one knows just how long the United States can continue to accrue massive debts before lenders lose confidence. Delaying significant fiscal restraint for yet another year will send the wrong signal to financial markets and may serve as a tipping point that could lead to disastrous consequences for our economy.
If U.S. creditors decide that our debt is no longer the safest form of investment available, demand for Treasurys will drop, interest rates will rise and the cost of servicing our debt will begin to explode. Paying interest on our national debt will quickly crowd out spending on almost all other federal priorities. At that point, any deficit reduction undertaken by Washington — including the sorts of spending cuts or tax increases being discussed today — will be too little, too late.
The Congressional Budget Office projects that under the most likely policy scenario, in 30 years, net interest payments on the debt could total $3.8 trillion in today’s dollars. That is more than total government spending for 2011.
In reality, we are unlikely to maintain the same level of borrowing and spending for the next three decades without a significant change in interest rates for our debt. Even a modest 1 percentage point increase, for example, in effect would wipe out all the deficit reduction included in last year’s Budget Control Act. In other words, we would have to shoulder the burden of fiscal restraint without any actual deficit reduction — all pain and no gain.
It could get much worse.
If our failure to make significant structural changes in government spending leads to borrowing conditions like those of Greece, we could experience a meltdown of the financial markets and broad economic upheaval from which we may never recover. Such circumstances would require massive and immediate cuts to Social Security, Medicare, national defense and virtually every discretionary program to avoid a credit default.
Most Americans will find this scenario difficult to believe, but make no mistake — if we do nothing, the avalanche will break suddenly and without warning. As Harvard economist Kenneth Rogoff recently explained, “By the time [markets] lose confidence, it’s too late: The option to tighten from a position of strength has evaporated.”
President Obama says his solution to our deficit and debt is to raise taxes on the very wealthy. His approach does almost nothing to address the structural spending challenges we face. Over 10 years, the president’s most recent budget, which includes his tax hike, still adds almost another $11 trillion to the national debt.
Equally unserious is the suggestion by some senior Senate Democrats that we increase spending with another stimulus program. Failure to achieve robust recovery is not the result of too little government spending. Rather, excessive government spending, intervention and regulation have stifled growth and incited fear over what will be required to bring the budget into balance.
What our country needs most is fiscal restraint, structural spending reform and sound economic policy to promote investment and jobs. Simply continuing to kick the budget can farther down the road will make these required reforms increasingly more difficult and ultimately more painful. Such continued delay risks arriving at a point when we no longer can borrow and we have no choice but to painfully slash government spending overnight.
Is Washington up to the challenge? So far, the answer has been no. That must change soon. If the fiscal avalanche breaks before we change course, the result will be disastrous.
Originally published in the Washington Times http://www.washingtontimes.com/news/2012/nov/23/after-fiscal-cliff-comes-fiscal-avalanche/