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The non-European countries always enjoy themselves by pointing fingers at the weaker European countries as the main culprits of the current economic crisis and Greece, Spain and Portugal are always being targeted as ‘worrisome’ countries. Even China, which is still experiencing a growth rate of 6% is being used as a reason for the weak world economy. However, the situation of the US economy isn’t that great at all.
In fact, the Federal Reserve has practically no other choice but to keep the interest rates at a very low level, as a following a path with increasing interest rates would be disastrous for the country’s budget. A lot of people seem to be forgetting the government/GDP ratio of the USA has increased to in excess of 100% and that already is quite an alarming level. Whereas the ratio was just 64% right before the crisis, the net debt has just exploded under the reign of the current president.
Source: tradingeconomics
But what would this result in, if the Federal Reserve would indeed continue to increase the interest rates? Well, the impact would be devastating as a higher benchmark rate would also force the USA to pay a higher interest rate on its government debt, and every 1% increase of the cost of debt results in an additional deficit of $180B per year. David Wessel, a director of the Hutchins Center on Fiscal and Monetary Policy has used an interesting chart. Even though the starting point is showing a flaw (the official government debt/GDP ratio is already 100%), the government debt will only increase.
Source: David Wessel presentation
You can clearly see the total debt/GDP ratio will increase to 160% within two decades and if we adjust the starting point of the calculation to make sure the current ratio is being used, the net debt/GDP ratio will reach 200% within 25 years from now. Assuming a GDP growth rate of 1.5% in the next 20 years, this would result in a total debt of 50 trillion dollar. That’s right, 50,000 billion dollar. If we would assume the USA will have 375 million inhabitants by then, the total government debt will be in excess of $130,000 per person (so roughly half a million dollar for a family of four). Throw in the traditional household debt, and you’ll understand why we aren’t too optimistic about the future!
And oh, yes, if the long-term interest rate would be 3%, the $50T in debt would cost you, the taxpayer, $1.5T per year to service it. Again, using 375M citizens and 275M tax payers, the interest expense per tax payer would be $500/month, and that means not a single additional dollar would/could be spent on anything else!
Source: brookings.edu
There’s only one solution for this, and that’s a prolonged period of low interest rates, and that’s exactly what the previous chairman of the Federal Reserve has been talking about. Bernanke claims this probably is the easiest and most clean approach to try to pull one last trick before the music stops.
But let’s face it, there is no way out of this. The Fed is almost out of ammunition and the only ace up its sleeve (apart from helicopter money) is to try to reduce the longer term interest rates resulting in a vicious circle of decreasing interest rates. And ask Japan how that worked out for them...
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