Government finances have reached the point where default and/or bankruptcy is unavoidable. After all, we've already started to monetize the debt. The inflection point occurs when total debt reaches a point that interest on the debt accumulates exponentially, engulfing the government's budget. As this occurs at a time when the economy is already weak and running deficits, essentially, there is no way out.
Significant runaway inflation and currency depreciation result from a government that can no longer fund itself. It starts when the market sees the problem and moves rates higher. The government must then monetize its debt to prevent interest rates from rising. Let me explain where we are and why severe inflation is unavoidable and likely coming in the next two to three years. . .
In FY10, the government paid $414 billion in interest expenses; that equates to 17% of revenue. When you account for the $14 trillion in total debt, it works out to be 2.96% in interest. In FY07, total debt was $8.95 trillion but the interest expense was $430 billion and 17% of revenue, so that accounts for an interest rate of 4.80%. Luckily, rates have stayed low for the past two years.
In the next 24 months, however, the situation could grow dire. At least $2 trillion will be added to the national debt. At an interest rate of only 4.0%, the interest expense would be $600 billion. Even if we assume 7% growth in tax revenue, the interest expense would total 22% of the budget. An interest rate of 4.5% would equate to 26% of the budget.
On just what level of interest expense is the threshold for pain, Russ Winter writes:
Once interest payments take 30% of tax revenues, a country has an out-of-control debt-trap issue. When you think clearly about it, this just makes sense, as the ability to dodge, weave and defer is pretty much removed, as is the logic that it will be repaid in a low-risk manner. The world is going to be a different place when the U.S. is perceived to be in a debt trap.Is there any way out of this? Either the economy needs to start growing very fast or interest rates need to stay below 3% until the economy can recover. Clearly, neither is likely. As you can tell from the calculations, interest rates are now the most important variable. If rates stay above 4%–4.5% for an extended period of time, there is no turning back.
Judging from the chart below, the secular decline in interest rates is likely over. It's hard to argue with a double bottom, one of the most reliable reversal patterns.
In 2011 and 2012, the Fed will have two new problems on its hands. First, the Federal Reserve will be fighting a new bear market in bonds. It will be fighting the trend. It didn't have that problem from 2008–2010. Further, the interest on the debt will exceed 20% of revenue; therefore, the Fed will have to monetize more as it is. Ironically, the greater monetization will only put more upward pressure on interest rates—the very thing against which Captain Ben and crew will fighting.
There really is no way out of this mess, which also includes the states, Europe and Japan. This is why gold and silver are acting stronger than they have at any other point in this bull market. They've performed great when rates were low, and are likely to perform even better when rates start to rise. This is why we implore you to, at least, consider gold and silver. We've created a service that offers professional guidance, so traders and investors can protect themselves and profit from this amazing bull market. Consider a free 14-day trial to our service.
Jordan Roy-Byrne, CMT