Wednesday, March 3, 2010

Interest Costs on the U.S. Federal Debt

Today’s graph comes courtesy of the Congressional Budget Office’s (CBO) The Budget and Economic Outlook, which was recently published [Note: graph is not well visible in this web page; click on the previous linked word, which will take you to the report. The graph is on page 1.] It shows the “past, present, and future” debt held by the public and the interest cost incurred by the Federal Government. The line denotes the amount of debt held by the public, which is measured by looking at the right-hand scale of the graph; the bars measure the interest rate costs, which is measure by the left-hand scale of the graph.

As can be noted, the costs over the last year declined, despite a ballooning debt. This was the result of lower interest rates and lower costs incurred from the issuance of inflation-adjusted debt. In fact, the CBO noted that interest payments declined by almost 26% ($65 billion) from 2008 to 2009. However, they project that this cost will more than triple over the next 10 years.

One must always take such forecasts with a grain of salt. I believe they will almost certainly be wrong. The actual numbers will be worse than what the CBO projects. History has proven this. I recall reading one of their reports in 1999. They claim that over the next 10 years (then) the U.S. would have paid down its debt. Of course, as it turned out they were a tiny bit off! Rest assured the same will repeat this time around.

Higher interest rates are surely on the horizon. There will come a point in time that U.S. debt buyers will recognize the true credit risk of holding Treasuries. They will demand higher yields. Consequently, this will put an additional burden on the fiscal position of the country. Unless the country truly puts its fiscal reigns on, this is pretty much a foregone conclusion.

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