What happens to a country with $23 trillions in debt when it encounters political instability?

Bob Melcher

 

Director and Owner (2017–present)

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What happens to a country with $23 trillions in debt when it encounters political instability?

We do not know. There is no similar model, so this situation is outside the realm of predictability. A year’s GDP in debt for a major power is so unusual (Post WWII) that we can only guess.

Guess:

We might be able to use the fall of the British Empire as a model. The Pound Sterling was the preferred reserve currency across the globe, but when Britain lost India, the Pound was supported by a much smaller economy, with reserves being redeemed for real goods. Paper that had been “printed” months, years to almost a century earlier suddenly had to be honored for real goods that had to be created today. In a few decades the Pound fell in value by a factor of 4 creating 15 or so years of a moribund economy.

$23 trillion at 3% is supported by $690 billion dollars, or 3.5% of GDP. The same debt at 8%, which was the 30 year T-bill rate from 1977 to 1995 (5% minimum to 14% maximum) costs 1.84 trillion per year to support, or 9.2% of GDP. That’s more than all discretionary government spending ($1.4 trillion) and almost half of all current Government revenue. It would be a big hit. We would have to cut roughly a trillion dollars, or 71% of all discretionary spending.

How do Interest rates get from 3% to 8%? Interest rates are the acceptable cost of money plus a factor for risk. In 2010, people invested in no-risk devices that lost them a few tenths of a percentage point per year to avoid the 10 and 20% losses of other seemingly sound investments. So there was a negative risk factor for T-bills. In any other situation there would be a positive risk factor, which increases interest rates.

Risk factors involve loss of confidence and, for example, are:

• Inflation
• Dollar falling out of favor as a reserve currency
• Political upheaval if it affects the economy (trade war)
• Large war
• Big recession
• Incompetent fiscal management

What would happen:

Were there to be a loss of confidence in the dollar, then government borrowing would become more expensive. More expensive borrowing is not an answer to that cost; “printing” money is not an answer to that and there isn’t enough spending to cut to cover it.

So we would face inflation, and the victim would be people on fixed income. ie: old people and disabled people.

The economy would go flat or worse for decades and we would never regain our footing as the primary economic leader.

Complete disaster!

So the debt level needs to reduce NOW in terms of days of GDP (economic growth reduces debt as a ratio of economic activity).