Wednesday, March 10, 2010

A Simple Story, A Painful Ending

Let's have a simple conversation about debt to help understand some of the confusing numbers.

Imagine someone makes $1,075 per month and they spend $3,284 per month.

That means they are spending 3 times what they make.  They have to borrow $2,209 on the credit card just to survive and get to the following month.

Are you with me?

During the month of February our government collected $107.5 billion and they spent $328.4 billion.

They are spending 3 times what they make.  They had to borrow $220.9 billion this month just to survive and get to March.

This is a record monthly deficit.  To put this into perspective, the deficit for the entire year in 2008 was $460 billion, an all time record before it was smashed in 2009.

It was $220.9 billion this month.

The average interest rate on the debt this month was 2.5%: an all time record low.

The Federal Reserve currently has the Fed Funds rate at 0%, and they are a major buyer in the treasury market.  If they were to even hint that they were thinking about raising rates, or slow their treasury purchases, rates would surge.  How high would they go?

As recently as September 2007 the average interest rate on US treasury bonds was at 5%.  Back in 1980, rates were at 15-20%, so 5% is considered historically low.

If rates were to just go back to that low rate of 5%, with the estimated $14.3 trillion in total debt at the end of 2010, then the yearly interest cost would rise to $500 billion annually next year.  That is only the interest.

The Federal Reserve cannot let interest rates rise.  They are boxed into a corner.  My guess is they are already purchasing a far greater amount of treasury debt than they are telling us.

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