Armageddon of Debt

If Wall Street’s debt crisis was traumatic, wait until you see the blow-out of Washington’s debt crisis. Never before has the US debt been financed so massively by foreign investors. Once Mexico, Spain and Argentina accumulated so much debt, they were forced to default.

In the 20th Century, a similar fate befell Germany in 1932, China in 1939, Turkey in 1978, Mexico again in 1982, Brazil and Philippines in 1983, South Africa in 1985, and latest Russia and Pakistan in 1998. Argentina kicked of the 21st century with a default in 2001.

One striking difference of these examples versus the debt crisis striking a dominant world power is that the debts of these examples represent little more than a small fraction of the total debts outstanding worldwide. Not so in our case today!

The US government and its agencies have, by far, the largest pile-up of interest bearing debts (US$15.6 trillion), the largest accumulation of unsecured obligations over US$60 trillion, the largest yearly deficit of US$1.6 trillion and the greatest indebtedness to the rest of the world of US$4.8 trillion.

In proportion, one could argue that Japan does have more debt than the US, but one should also note that nearly all of Japan’s are financed by its own citizens.

By implications, we cannot deny the possibility of sharply higher interest rates. Already, despite the weakest post-recession recovery in memory, bond prices are plunging and their rates are surging. Just a few weeks ago, the yield on 30-year Treasury bonds busted through a declining trend that had not been penetrated in more than 20 years. And just last week, it came within a hair of its highest level in over two years.

When Uncle Sam has to pay more to borrow, all of us inevitably have to pay more as well. Rates on mortgages and car loans will surge for simple reason that they are also tied at the hip of long term Treasury rates. Worse still for variable rate mortgages as the impact of surging interest rates will be even more traumatic.

The fledging recovery in housing and auto sales – the pride and joy of Washington’s bail out bridgades – will probably be toast. Institutions and individual investors holding piles of lower yielding long term bonds will get killed. All in all, we could suffer a chain reaction of defaults.