The argument that the past 10 years of low interest rates has just been an anomaly which will normalize to higher levels in the next couple of years is not going to unfold. Interest rates will be perpetually low for the rest of our lives! Here’s why.
- The green line above represents our total debt as a percentage of GDP;
- the purple line is the historic 10 yr Treasury Note rate which we are using as a proxy for the average interest rate on total debt (AIR) and
- the blue line is the interest payment on our total debt as a percentage of GDP (again using the 10 yr rate as a proxy for average interest rate on total debt) let’s call it DSGDP.
- (The above relationships were regressed and found to be both statistical significant and with good explanatory properties.)
- total debt as a percentage of GDP (green line) recently exceeded 100% and,
- as the green line increases, the spread between the purple and blue lines gets smaller. This is really just an algebraic principle. Historically the blue line is essentially a fixed rate (within a range) and so as the green line moves up the purple line (AIR) must move down so the DSGDP stays within the fixed range.
- as total debt became a higher percentage of GDP the average interest rate on debt must move down toward that 2.5% line that we’ve held for 15 years.
- As the total debt to GDP moves above 100% (and even the CBO is forecasting debt to GDP to continue rising for as far as the eye can see) we will start to see the average interest rate on total debt (the purple line) move below 2.5% in order to keep the DSGDP around the 2.5% 15 year average.
In the future:
- If average interest rates on debt were to move back to the 20 yr average of 7.5% then our interest payments would take up 7.5% to 10% of our GDP – and that is something we simply cannot afford.
- The most our average interest on total debt can move in the near term is to around 4% which would take us to the high end of the historic DSGDP range…
- In 5 or 10 years time total debt will be sufficiently more than GDP that even 4% will be unsustainably high.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
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