Sunday, July 3, 2011

What Is the United States’ Default Interest Rate?

It is becoming clear that there are many people, including people in Washington, who don’t fully appreciate the difference between one interest rate and another. When they hear that the United States government is days away from falling into default by failing to make interest payments, it doesn’t bother them at all. Some politicians have said they’re not so sure a default will affect anything. But the effect of a default becomes obvious when you consider the effect of interest rates.

It is easy to see with a credit card account, so imagine it this way. You know you have to make payments when the bank says you should. If you aren’t careful about doing this, you find that your interest rate changes one day. Perhaps it was 4.9 percent yesterday, and today it’s 29.9 percent. And it’s going to stay at that higher level. You may have to pay off your entire balance, then wait several months before the bank will consider lowering your interest rate to 4.9 percent again. In the meantime, your new interest rate of 29.9 percent is what you have to deal with.

This is a really big deal if your credit card balance is $10 trillion. If you thought it was hard to pay the interest charge of $40 billion every month, imagine how hard it will be to pay $250 billion month after month. If it was hard to balance the budget before, it may not be possible now that you have to tighten your belt to the tune of another $1 billion per day.

The big question, though, is this: what is the United States’ default rate? No one really knows, but so far, there is no indication that it will be different from anyone else’s default rate. It will probably be somewhere between 22 and 34 percent. Anywhere in that range, interest payments would be larger than federal tax revenue. That means, at that point, even if we shut down the entire federal government and continued to pay all our taxes, the United States would still continue to fall deeper in debt day by day. And this is not some far-off, distant, hypothetical scenario. It is just days away from happening — and just because of an interest rate change.

The important thing to understand politically is that Congress created this problem by putting the federal government into bankruptcy. It can solve the problem at will, just by voting to take the federal government out of bankruptcy. But it has to act soon, within the next few days. The federal government’s interest rate has already started to creep upward.