Getting Ready for the Next Economic War: Interest Rates

economic recoveryAt the end of September 2011, the government’s last fiscal year, the U.S. national debt stood at roughly $14.79 trillion. According to the U.S. Treasury, the interest payment on the U.S. national debt was just over $454 billion last year. Therefore, if we divide $454 billion of interest by $14.79 trillion of U.S. national debt, we get three percent.

This means that the interest rate the U.S. government paid on the U.S. national debt was approximately three percent for fiscal 2011.

Herein is where the lies problem, dear reader. The government is very much like a household with too much debt. Clearly paying down the debt becomes a priority, but all of the budget forecasts can be thrown out the window if the interest rate on the U.S. national debt rises—just like for a household.

Before we get carried away and assume that current interest rates are normal, we should keep in mind that historically (since 1962), average U.S. interest rate have been in the five percent to six percent range. What would happen if interest rates returned to historical norms?


At an interest rate of five percent, the interest costs on the U.S. national debt would reach approximately $755 billion. At an interest rate of six percent, the interest on the U.S. national debt would reach $930 billion. Just below seven percent is where interest rates would need to be to reach the $1.0-trillion mark in interest costs on the U.S. national debt.

Let’s assume the best-case scenario, with interest rates returning to historical norms of just five percent, which is not a stretch, especially with the rapid commodity price inflation we are experiencing today. In fiscal 2011, U.S. government total receipts, money coming in (which is equivalent to total revenues for a company or total family income for a household) was $2.3 trillion.

If we divide the current interest on the debt of $454 billion into $2.3 trillion, we find that 20% of every dollar the U.S. government takes in—taxpayer money—goes towards paying the interest on the U.S. national debt. If interest rates were to rise to five percent, then the interest costs on the U.S. national debt would be about $755 billion or approximately 33% of all the receipts—taxpayer money—the U.S. government takes in. That’s about one-third of all money coming in just to pay interest on the debt! How ridiculous is that?

And the U.S. national debt is increasing, not decreasing!

As a household, the last thing the government wants is for interest rates to rise, because it will cost the government dearly.

But if the market forces interest rates to rise, then, in the short term at least, it would mean the Federal Reserve would have to buy the U.S. national debt itself to keep rates from rising. This means printing more money. Got gold in your investment portfolio?

Michael’s Personal Notes:

The U.S. durable goods report is an important gauge of an economic recovery, because it focuses on big-ticket items that are purchased by businesses and consumers, which are meant to last at least three years; a sign of business and consumer confidence.

In January 2012, U.S. durable goods orders fell 3.6% from December’s level (source: U.S. Commerce Department), which missed expectations by a wide margin. But economists and the media told us not to worry; with the economic recovery supposedly intact, February’s numbers were expected to come in showing accelerated growth of three percent over January’s number.

February’s durable goods number is in now…and they rose only 2.2% in February, illustrating that the economic recovery doesn’t have the legs some assume it does.

Orders for durable goods excluding defense and aircraft are an excellent measure of not only future business investment, but also of consumer confidence. They reflect consumer confidence in the economic recovery, because only confident consumers will go out and spend on big-ticket items.

In January, orders for durable goods excluding defense and aircraft actually fell 3.7%. For February, the number came in slightly higher at 1.2%; not a meaningful acceleration in this economic recovery.

One of the supposed bright spots in the report was the increase in machinery orders, but it has also been the 23rd consecutive month that inventories in machinery orders have increased!

Furthermore, the report noted that all manufactured durable goods inventory have increased for 26 consecutive months!

I highlighted the latest GDP figures earlier in the year, dear reader, and pointed out that there was a lot of inventory restocking that made the number look better than it actually was.

Inventory is a tricky thing. If strong demand comes in from a sound economic recovery and buys up the inventory, then fantastic. The business owner is in an enviable position of ordering more goods—or durable goods—because of a self-sustaining economic recovery and consumer confidence.

If demand doesn’t materialize, however, then the business is left with inventory on its shelves and an economic recovery that dims the prospects of selling that inventory.

In 1992, the U.S. Department of Commerce remodeled the way it calculated the durable goods report. The Commerce Department noted that inventories for manufactured durable goods increased $1.6 billion in February of 2012 to a record $373.7 billion.

consumer confidence

As the chart illustrates, the economic recovery and consumer confidence had better find their legs, and soon, or that inventory is going to be a drag on growth going forward. Also, notice the pattern, dear reader, which came to a peak in the middle of 2001, and then fell with the recession.

Inventory began to grow again with the economy recovery, sometime in early 2004. When the latest recession hit in 2008, inventories began to fall again, only to recover toward the beginning of 2010.

Since then, inventories have been on a relentless climb upwards. Does anyone want to wager when the peak turns down again?

As both the GDP and the durable goods report show, dear reader, there has been a heavy reliance on inventories to boost the numbers. Without an economic recovery, these inventories are going to exacerbate the downturn. Watch out for that stock market rally!

Where the Market Stands; Where it’s Headed:

There is no doubt: it was a spectacular first quarter for the stock market. The Dow Jones Industrial Average gained 994 points in the quarter ended March 31, 2012—a gain of eight percent. Stocks just had their best first-quarter performance in 14 years!

Dear reader; I think we might be getting to the point where the bear market rally that started in March of 2009 is making its final upside gasp. I research and analyze the economy every day. I believe the economy has been held up the past three years only by record-low interest rates, accelerated government debt, and money printing—something that cannot continue. Inflation is pushing the limits right now.

What He Said:

“The Dow Jones Industrial Average, the S&P 500 and the other major stock market indices finished yesterday with the best two-day showing since 2002. I’m looking at the market rally of the past two days as a classic stock market bear trap. As the economy gets closer to contraction, 2008 will likely be a most challenging economic year for Americans.” Michael Lombardi, Profit Confidential, November 29, 2007. The Dow Jones Industrial peaked at 14,279 in October 2007. A “sucker’s” rally developed in November 2007, which Michael quickly classified as bear trap for his readers. By mid November 2008, the Dow Jones Industrial Average was at 8,726.