As we lie perched on the fiscal cliff’s very precipice, it’s worth considering for a moment the dog that has not barked amid all the economic tumult of recent times: interest rates.
The Fed has succeeded, so far, in maintaining near zero rates. This zero-rate policy has encouraged investors to participate in financial markets, both stocks and bonds. If rates should spike, unexpectedly, stocks and bonds are likely to take a significant hit.
So too at the macroeconomic level, a rise in interest rates would be a game changer.
We already devote 6.31% of the budget to service the debt. That’s significantly more than we spend on all U.S. military personnel. It’s more than the combined total of what we spend on unemployment insurance, earned income and child tax credits and housing assistance to the poor. It’s one of the biggest single items in the federal budget.
If rates rose, all the political deals Democrats and Republicans have hinted at but not had the courage to adopt will instantly be deficient in revenue by tens of billions of dollars. (We’re currently spending $220 billion in annual net interest payments.)
To be clear, rising rates is not inherently a bad thing. It could even be the best thing that could possibly happen since Americans would once again be rewarded for the discipline of saving and politicians would be forced to make real choices between guns and butter.
But realistically, the void of leadership today signals a different path, specifically that the slow-motion train wreck Europe has been going through for the past three years may be our fate as well.
A little history will help. Europe’s various sovereign debt crises started when investors began to doubt Greece’s ability to pay its bond investors.
Bond yields and the cost of credit default swap insurance rose. When Greek bonds were downgraded to junk status, the EU and IMF crafted a bailout package.
But what seemed at the time to be a temporary scare that European Union summiteers would make go away has only widened in a domino-like chain of misery, first to other “peripheral” European countries, but soon enough to Europe’s wealthy core.