Remember the good old days of ten years ago? Think back to the years between 2001 and 2007 where the value of your house went up 20% a year and interest rates just kept on slowly but surely dropping. It was so easy to buy stuff at Home Depot and Wal-Mart on a credit card and buy vacations on a home equity loan and then every 18-24 months just refinance your home mortgage. All the credit card and home equity lines got paid off by cashing out the increased value of your house and because the interest rate was lower your mortgage payment barely even went up.
Yeah, life was good.
Then a strange thing happened that every expert on the planet said could not happen because it had never happened before. Home prices nation wide stopped going up and then despite what the experts had said they began to fall, everywhere. It took a while for reality to set in but as the credit cards began to reach their limits and the home equity lines got maxed out people suddenly couldn't afford the payments and the refi option was no longer an option. You know the story, it's been talked about to death. If you had a variable rate loan the story is even worse. Those people who took the really easy short sighted way ended up in deep deep trouble. Honestly, anyone who took out an interest only loan at 2% for the first two years and then variable after that and then was surprised that they couldn't afford the loan two years later deserves what they got. They gambled that they would be able to sell the house for a profit in two years and the bank gave them the loan for the very same reason. The buyer was greedy and so was the bank and neither one deserved to get bailed out.
The United States government has taken the exact same approach as a sub prime home buyer with managing our economy. Our government is now sitting in the exact same spot as a sub prime homeowner just after their introductory rate has expired. We have continued to borrow money at an ever increasing pace and have not yet felt the pain of this borrowing because we continually refinance our debt to a lower and lower rate. Something absolutely catastrophic occurred in November of last year that very few people know about or are willing to admit.
The Federal Reserve Bank is in charge of managing our money supply and setting interest rates. Over the last few years in order to bail out the banks and slow the housing crisis they lowered interest rates to zero. They've taken their ability to control the economy via interest rates to the max. At an interest rate of zero you obviously have no where else to go. The other thing the Fed can do to try and control interest rates is buy long term treasury bonds. That's what they resumed doing back in November at the rate of one hundred billion dollars a month. If you consider the fact that the government is currently issuing new debt at about the rate of one hundred billion a month you realize that the Fed has also reached the limit on their ability to buy bonds. If they started buying bonds at a rate greater than the government was issuing new bonds they would start sucking them out of the system and absolutely flooding the system with cash. Effectively they have maxed out the tools they have available to them to control interest rates.
What's happened since November is that despite the Fed's maximum effort to lower long term interest rates they have increased from 2.54% in November to 3.68% as of the moment this is being written. That is a 45% increase in the effective interest payment on that debt at a time when maximum effort is being applied to pushing the rate lower. The sub prime borrower that is the US government has lost control of the interest costs on its debt. In 2010 the government paid only 3.1% in interest on the national debt, a mere 413 billion dollars, down from over 453 billion in 2008 but up from 383 billion in 2009.
We were able to gloss over our 1.4 trillion dollar increase in the national debt in 2009 by pushing the interest we pay on the debt down from 4.5% to only 3.2%. The 1.3 trillion dollar increase in 2010 was followed up by a reduction in interest paid from 3.2% to 3.1%. That rate reduction was too small to offset the massive increase in debt so we ended up with an increased payment of 30 billion compared to 2009. The 3.1% number is an all time low and for all effective purposes represents the absolute minimum we can ever expect to pay. The fact that rates have been rising steadily in 2011 signals the start of a feedback loop that will soon end like every other sub prime homeowner ended, in foreclosure.
The sub prime analogy is very useful in this case since one of the ways the government has been effectively lowering its interest payments is to shorten the terms of the debt. Treasury bonds are issued in a variety of maturity levels ranging from as short as a month to as long as 30 years. The shortest term bonds have rates as low as 0.21% while the 30 year bonds are more in the range of 5% with the benchmark 10 year sitting in between at around 3.6%. The average term of all our outstanding bonds has dropped to around 4 years meaning that all of our debt needs to be refinanced within a 4 year period. When rates are falling this is good since you keep refinancing to a lower rate but when rates are rising it is very bad since existing bonds are replaced with new bonds at a higher rate. We have a problem that even the very problematic countries in Europe don't have with our extremely short term debt. The European countries have closer to a 10 year average term on their bonds so interest rate increases won't effect their existing debt nearly as much. Forget the PIIGS in Europe it is the United States that is really stinking up the place.
It's being projected that we will add about 1.5 trillion to the national debt in 2011 which is more than a 10% increase in a single year. If the interest rate were to only remain constant then our payment would also increase by 10% but if you factor in a rise in interest rates you could see a total increase of 25% or more in just a single year. If we go all the way back to the interest rates of 2008 the interest payment on our debt payment jumps to 720 billion making it the single largest expense in the Federal budget consuming over 1/3 of all tax revenues.
The effect of zero interest rates and constantly pushing 100 billion a month in cash into the system is inflation. The rising price of commoditities and energy are strangling our economy and causing chaos around the world. At some point it is going to have to end or the rest of the world is going to turn on us and start rejecting the US dollar. The only way to combat inflation is to hike interest rates and reduce the money supply. I hope you see trap we are caught in. Even a small rise in interest rates makes our interest payment too large to sustain. At this point we are borrowing the money being used to make the interest payment thereby making the interest payments grow larger and larger. That's a feedback loop and if you've ever put a microphone too close to a speaker you know how quickly a feedback loop goes from nothing to an absolute horror and then clicks off once the system burns out.
In the case of a debt feedback loop the horror is seeing the interest payment consume 1/3 then 1/2 then 3/4 and finally all of the tax revenue being collected. When every single dime being taken from people is going towards paying the interest on things we've already bought is when the system burns out. At this point or maybe even before it will be necessary to simply default on our debt and simply stop paying the interest. I'm no expert but I don't think that China, Japan, England and the US population is going to take too kindly to being told their 15 trillion dollars in bonds are now worthless.
In the end, timing is everything and the Fed is going to do everything it can to simply buy more time. Nothing has been fixed or has started to recover since 2008. Extraordinary measures are being taken to hold this sinking ship afloat long enough for the insiders and real power brokers to position themselves to profit from the collapse. There won't be a one day lights out kind of event with this collapse the way the Fed is managing it. The economy is like a cancer patient being given ever larger doses of pain killers so that everything feels somewhat normal but the deterioration that's occurring cannot be denied.
If you have short term variable rate debt you need to eliminate that debt as soon as possible. If you depend on government programs like Medicare, Food Stamps or Social Security to survive or are employed by the government or a company that depends on the government then you need to prepare. These things will not survive this decade in their current form. The math is impossible to deny.
The good news is that once this collapse is complete we will have a chance to return to our founding principals of self reliance, liberty and limited government. We will have yet another example of collectivist failure to learn from and hopefully never repeat. I believe our constitution is strong enough to survive this collapse and to start us back on the path of true prosperity once we return to knowing and living by its tenants. This cancer patient will go through painful surgeries and treatments to remove the cancer of collectivism but once it is gone we will be free to pursue our individual dreams alongside a government dedicated to protecting our life, liberty and property with no intentions of doing anything more.