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Under Boehner Plan, most of the spending cuts will be eaten up by higher interest rates

by Aaron McCormack on July 30, 2011

Similar to the new Greek bailout in Europe, where Greece will actually end up paying more rather than less, the House plan for deficit reduction in the United States COULD see the US INCREASE its deficit, not reduce it.

Simply put, a plan that does not prevent a credit downgrade for the USA will mean that the the US government has to pay more interest on both its existing and new debt.

It doesn’t take very much of an interest rate hike to eat up the spending cuts.

You can see a more detailed explanation from the excellent Irish economist Dr Constantin Gurdgiev here (“Some Uncomfortable US Debt Arithmetic”)

But let’s take one of his examples from the Boehner Plan passed by the House last night.

If US borrowing rates (as defined by the interest rate on Treasury bills) rise to only 4% from the current rates of around 3.3%, and if the Boehner cuts occur uniformly over the next 10 years, then the deficit could actually rise by over $800bn over the period.

If the next course of action in Congress is to reach a deal is to back-end load the cuts and do nothing on revenues, then the sums get worse.

THIS IS WHY A GRAND BARGAIN AND SUBSTANTIAL DEFICIT REDUCTION PLANS ARE A MUST.  There are two drivers for this…

1. The country is on an unsustainable path and large amounts of both new revenues and cost reductions are vital

2. Anything that triggers a ratings downgrade and a rise in borrowing rates for the US Government will eliminate a lot of the savings made.

As I keep saying here, it is not debt level itself that is the killer for an otherwise-solvent country – it is the interest payments.  The ratings agencies and lenders will want to see a plan from lawmakers that makes a massive change to the current direction, not a nudge on the tiller.

And to create the headroom for important investments in infrastructure and education (for future competitiveness) the country needs to minimize its interest payments.

Spread the word….a credit downgrade is nearly inevitable at this point but the right plan would see a return to the highest rating.

From → General, Politics, USA

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