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The potential 'economic catastrophe' that no one is talking about

Danger
Chris Kryzanek | Getty Images

Most economists believe the Federal Reserve will, once the election is over, raise interest rates at its December 2016 meeting. There are many after-effects to this long awaited move, and most of them have been widely pondered by the economic talking heads in the media.

Yet there is one effect of rising rates that will have a potentially devastating impact on our economy that hardly anyone is talking about.

During the eight years of the Obama administration, two economic events occurred which befuddled most economists: Our total national debt rose from $12.3 trillion to $20 trillion while interest rates sank to a new all-time low. (The national debt figure includes money owed by the government to itself. The debt held by the public is what interests us since the government must pay out the interest to these bond holders.)

"Under this 2020 scenario, one-half of all personal income taxes would go to servicing the national debt."

In 2009, the year President Obama took office, the national debt held by the public was $7.27 trillion. At the end of fiscal 2016, that had soared to approximately $14 trillion. Given that our marketable debt doubled from 2009 to 2016, it's remarkable that the annual cost of the interest on the debt rose far less, from $185 billion to $223 billion. Thank you, Federal Reserve. Could this be the main reason interest rates were kept so low?

We now face a potential economic catastrophe as the long period of very low interest rates comes to an end. If the Fed raises interest rates in December, this may be the beginning of a climb back to historic rates. What are the historic rates, you may ask? We calculate that the average rate paid on the federal debt over the last 25 years was 5 percent. In addition to the Fed's upcoming action, wage pressure and other such signs are hinting at a rise in inflation which will also add to the pressure on interest rates. And if we get back to that 25-year interest rate average, watch out!

The math is simple. The non-partisan Congressional Budget Office forecasts that debt held by the public will rise to $16.5 trillion in 2020. Now you may have your own views on that, since some will make a good case it will be higher. Indeed, if you look at the economic plans of both presidential candidates, most scoring exercises indicate that both will produce higher deficits. For our exercise though, let's stick with the CBO estimate. We are postulating that the interest rate on our national debt may well return to the long-term, 25-year average of 5 percent.

Now take the CBO estimate of debt held by the public of $16.5 trillion in 2020, a 5 percent average interest on that amount comes to annual debt service of $829 billion, a staggering amount.

Let's put it in perspective:

Individual income taxes in 2016 produced $1.6 trillion in revenue.

  • Under this 2020 scenario, one-half of all personal income taxes would go to servicing the national debt.
  • Debt service in 2020 would dwarf our military spending of $585 billion in 2016.
  • Debt service would consume nearly two thirds of Social Security obligations.

Note: We are using 2016 numbers for comparison. It is likely that all these numbers will be higher in 2020 but the proportions will likely be similar or worse.

These numbers are staggering, all the more so because the assumptions we use are eminently reasonable and predictable. This trend is the consequence of our failure to pay enough attention to the national debt and the effect of rising interest rates. Who will tell the American people that in a couple of years, over half their income tax payments will go to pay interest on the debt to Japan, China and all the others who buy American bonds? Who will tell the American people that that the debt service we pay will be far greater than our expenditures for the military?

And who will take the blame when the American people demand accountability for this untenable, yet predictable, state of affairs?

Commentary by Peter J.Tanous, chairman of Lynx Investment Advisory in Washington, DC. He is also the co-author with Jeff Cox of "Debt, Deficits, and the Demise of the American Economy" and "The 30-Minute Millionaire." Follow him on Twitter @petelx60.

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