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Charting the Economy, Part 5

Wed, Mar 30, 2011 - 10:25am

In Part five of the series Charting the Economy, we examine Debt. This series is intended to present a recent history of the economy in an easy to understand format using graphs. You can find Part 4 here.

US Debt has increased 2.5 times since the start of the decade, but the interest expense has not increased by the same amount. The low interest rate allows debt creation to soar to dangerous levels. The major risk here is that if interest rates rise, the US could face not being able to pay the debt service. Inflation can help with paying off long term debt, but short term debt is much harder to rollover in an environment of rising rates.


Low interest demanded by creditors have allowed the US to borrow it’s way to potential economic insolvency.


debt and interest

Debt has caught up to GDP in early 2011. The growth rates of debt are stunning, and prove that additional debt does not automatically increase production.

Kenneth Rogoff and Carmen Reinhart, in their book This Time Is Different, note that when debt exceeds 90% of GDP historically, growth rates in that country slow 2% over countries with lower debt thresholds. When debts reach 100% of GDP, default is much more likely. The US is facing this dynamic even as official budget projections forecast GDP increases for the next several years.

Typically, countries experiencing greater than 20% inflation also have a higher chance of defaulting on debt. The US is not quite there yet. You can view real inflation in Part 4.

gdp and debt

Here is why US borrowing costs are rising, as shown in the previous chart. We can see that after the financial crisis, rates that had jumped up from previous years had fallen again. The public bought into stabilization of US debt. The rates are beginning to rise again, though not as much on the shorter issues. The public obviously feels there is much risk on the horizon, but not in the immediate term. However, shorter term securities have levelled out in 2011 and it would not be a surpise to see them jump as well, if the economic conditions do not improve. If short term rates rise, this could make it very difficult for the US to finance it’s debt. The Federal Reserve would have to continue to pump freshly printed currency into the system, risking hyperinflation.


Note: The US did not issue 30 year Treasuries for 2003 – 2005.

The Federal Reserve bank, known as the central bank of the US, has twice in the past few years vaulted to the top as owners of Treasury Debt. Once during the mortgage meltdown and again as the economic recession in America continues.

This process of central bank buying debt is called monetizing the debt, and is often one of the final warning signs of debt collapse. China and Japan have been slowly deleveraging out of US debt and building portfolios of hard assets such as commodities. The market for US debt paper is increasingly falling to the Federal Reserve to fund. The US is running large budget deficits, which puts increasing pressure on additional yearly borrowing to make the difference up. Because rolling over previous debts requires new debts to be created, it will be interesting to see if anyone else has the capacity and willingness to take on additional US IOUs. No suitors have volunteered and there may not be any capable to do so.

holders of debt