linked down

How the United States will go Insolvent

Charles Hugh Smith has a fantastic, easy-to-follow post today titled, The Road to National Insolvency. Therein Smith details the debt-rolling finance structure that the United States Treasury has employed to pay off existing debt, interest on said debt and new deficit spending. He then explains how current factors have kept a lid on borrowing costs (interest rates or bond yields) on Treasuries. Finally, he speculates on how going forward the dampened global economy and demand for yield by investors (i.e. investors will only accept marginal yields on debt for so long) will put enormous upward pressures on borrowing costs, thereby ultimately leading to much higher interest rates, sovereign debt-servicing costs and finally to U.S. insolvency.

I happen to agree with Smith, so I’m biased in that regard (Disclosure: short TLT via puts and long TBT). I think the biggest unknown is just when we hit the tipping point and yields start spiking dramatically. It could happen very quickly and with little notice. So be careful out there!

Well organized, written and worth the read in it’s entirety: the clip below is just CHS’s conclusion:

Four short years of $2 trillion deficits will effectively double the U.S. national debt and the interest it pays. The Social Security surpluses are “borrowed” every year without any notice, so the U.S. debt rose by $300 billion a year even when it supposedly ran a slight surplus; that $300 billion+ a year in new debt goes on top of the stated $2 trillion/year in deficit spending.

So the nightmare scenario is this: the debt doubles over the next 4-5 years, causing interest payments to double from $450B to $900B a year. But interest rates also double due to the global shrinkage of surplus capital and the monumental rise in demand for capital (borrowing). The $900B in interest then doubles to $1.8 trillion–roughly equal to Medicare, Social Security and the Pentagon combined.

Can’t happen? Really? With tax revenues dropping along with profits, employment and assets, then where will the political will arise to cap entitlements and other spending? I predict the U.S. will continue borrowing trillions of dollars until it is no longer able to do so.

By then, the interest owed each and every year will crowd out all other spending. With the debt machine broken, the government will simply be unable to service its debt and fund all its mandated entitlements and other programs. It will be insolvent.