Rising interest rates will soon have a devastating effect on our economy, mostly because of a single factor that hardly anyone is talking about.
The 10-year Treasury yield is about to cross 3 percent, a rate not seen since January 2014. Given our vigorous economy and stock market forecasters pricing in up to four rate increases this year, some credible economists are predicting the 10-year yield at 4 percent by year-end.
The single most dramatic effect of today's rising rates is the interest we will pay on our national debt.
During the eight years of the Obama administration, two economic events occurred that befuddled most economists: Our total national debt rose to $20 trillion from $12.3 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 matters to us since the government must pay out the interest to those bondholders. 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.
Some observers suggest that the staggering interest cost on the national debt is 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. The recent stock market meltdown has been attributed to rising rates. That is correct, but for the wrong reasons.
True, the long march of rising rates beginning now will be a dramatic change from the long trend of declining interest rates that started nearly 40 years ago. The new upward trend is likely the beginning of a return 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 30 years was close to 5 percent. And if we get back to that 30-year interest rate average, watch out.
The nonpartisan 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 people will make a good case it will be higher.
Sen. Rand Paul recently forced the government to shut down, however briefly, for the second time in two months because of his concern that our annual deficits were once again exceeding $1 trillion. Based on the current budget, he was right.
For our exercise though, let's stick with the CBO's estimate. We are postulating that the interest rate on our national debt may return to the long-term, 30-year average of 5 percent. Note, too, that Treasury debt rolls over every three to four years, so the bonds maturing at low interest rates will be refinanced at higher rates.
Let's engage in some grammar school math. Take the CBO estimate of debt held by the public of $16.5 trillion in 2020. A 5 percent average interest rate on that amount comes to annual debt service of $825 billion, an unfathomable amount. (In 2017, interest on the debt held by the public was $458.5 billion, itself a scary number.)
Here's the danger:
According to the CBO, individual income taxes produced $1.6 trillion in revenue in fiscal 2017.
- Under this 2020 scenario, one-half of all personal income taxes will go to servicing the national debt.
- Annual debt service in 2020 will exceed our newly increased defense budget of $700 billion in FY 2018.
- Annual debt service would equal our Social Security obligations.
Note: We are using FY 2017 budget numbers for comparison. It is likely that all the numbers will be higher in 2020 but the proportions will likely be similar or worse.
These numbers are staggering, more so because the assumptions we use are reasonable and predictable. This dangerous trend is the consequence of our failure to pay enough attention to the national debt and especially to the effect of rising interest rates.
Who will tell the American people that in a couple of years, almost 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 the debt service we pay will be 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?
Peter Tanous is chairman of Lynx Investment Advisory in Washington, D.C. He is the author or co-author of several investment and economic books, including "The End of Prosperity," co-authored with Dr. Arthur Laffer and Stephen Moore. His most recent book is "The 30-Minute Millionaire," with co-author Jeff Cox of CNBC.