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“Throughout our nation’s history, Americans have found the courage to do right by our children’s future … We cannot play games or put off hard choices any longer … If the U.S. does not put its house in order, the reckoning will be sure and the devastation severe … After all the talk about debt and deficits, it is long past time for America’s leaders to put up or shut up …”

Above is excerpted from the preamble of the so-called Simpson-Bowles report on deficit reduction – a report subtitled, “The Moment of Truth” That moment of writing was now a full year ago. The commission that. produced the report was instituted by presidential executive order after Congress failed to enact legislation proposing its formation in January 2010.

Its 19 authors (16 commissioners, one executive director, two co-chairmen) proposed a six-part plan to improve our fiscal health. It contemplated I) $4 trillion in deficit reduction through 2020; II) reducing the deficit to 2.3% of GDP by 2015 (presently ~8.4%); III) sharply reducing tax rates and abolishing the alternative minimum tax; IV) capping revenue at 21% of GDP (presently ~15.5%) and getting spending down to 21% (presently ~23.8%); V) reforming Social Security to preserve it, enacting cuts that don’t kick in until 2037; and VI) stabilizing the debt by 2014, reducing it [debt held by the public] to 40% of GDP by 2035 (presently ~67%, up from ~35% four years ago).*

By the commission’s own admission, “None of us likes every element of our plan, and each of us had to tolerate provisions we previously or presently oppose in order to reach a principled compromise … We do not pretend to have all the answers … We offer our plan as the starting point for a serious national conversation …”

That “serious national conversation” took the form, culminating four months ago, of holding raising the debt-ceiling hostage in order to enact deficit reduction. The result afforded us ultimately a $900 billion higher ceiling – an amount that would last us about eight months (from then-August) at our current rate of spending and income. With that came ~$900 billion in cuts over ten years and another potential ~$1.5 trillion in the same time – a total amount equal to less than one-fifth our current over-spending.

Two-thirds of those reductions (the $1.5 trillion) depended on a “super-committee” (which I yesterday heard referred to as Congress’ “Minnie-Me”) coming up with a plan as by today. Otherwise, “draconian” automatic cuts would kick in – as I’ve written, not until 2013 after the elections, and can be spread and back-loaded over a decade’s time. As you likely heard by now – and are probably not shocked by – the “super-committee” has announced effective failure, giving up before even reaching their official deadline. Both parties are blaming the other’s obstinacy as political maneuvering while we approach an election year, calculated to make the other appear to blame for the mess we’re all in.

And the president, the only seeming adult at the time when he formed the Simpson-Bowles-led commission, has yet to consider seriously any of its proposals; choosing instead to let Congress lead the way to, at what is at best, ineffectual or insufficient results.

Whatever the motives, both parties actually seem to believe that they can get away with this course. That is because the bond markets have, thus far, been giving us a pass. This is despite a credit downgrade – the direct result of political paralysis over these fiscal issues. Despite behavior that runs the very real risk of causing our interest rates to rise not insignificantly.

Our interest rates, for now, are at generational lows and not rising for several major reasons. Some of it is about capital running away from Europe’s debt crises; away from a China that is much more a house of cards than appears on the surface. Running to the only place left to run to – in a world challenged seemingly at every corner, to the relative “safe haven” of U.S. government bonds.

And some of it is our Federal Reserve, with its virtual unlimited ability – so long as the dollar does not collapse – to hold shorter-term interest rates at artificially low levels to stimulate the economy. They have been doing this now for four years. The economic result thus far – only about one-quarter of jobs lost in the 2008-09 recession recouped.

This has led bond market participants to conclude that the risks of being in some kind of potentially deflationary depression (good for bonds, at least initially, by lowering interest rates) are greater than the risks of causing inflation (bad for bonds) with overly-stimulative, low interest rates. (And, in my view, bond markets get it right earlier than stock markets do.)

This is the Japan scenario. They’ve been in some kind of depression for a couple decades now. If we don’t count Zimbabwe (and we shouldn’t), Japan’s public debt is the highest in the world – ~200% of GDP – the result of two decades worth of government overspending as a cushion for economic malaise. That’s ~40-50% more than Greece’s. Greece’s short-term interest rates are presently over 100% as a result of their fiscal ineptitude. Japan’s, although also run by inept and corrupt politicians in my view, have been near-0% for over a decade.

So, so long as bond markets are convinced America remains in the zone of some kind of depression, we will not reap the consequences of fiscal inanity through skyrocketing interest rates – which is not my recommended plan of action. And this is what our politicians, I believe, are thinking to themselves (to the extent they actually think about these things at all). It seems to me, they figure the US can continue with very low interest rates, despite their shenanigans and fiscal impropriety, because Japan has somehow gotten away with it for years themselves.

That is a risky game to play. But that they would even dare, should demonstrate to us the seriousness of the hole we are digging.

But we have not reached that “event horizon” yet; that point from which we can no longer escape. Yes, over the past few years, we have almost doubled our debts. Having said that, debt size actually does not matter. Nor does running deficits. Government can run deficits forever – and that can actually become a competitive advantage over other nations. Just run deficits that grow your debts less than the real growth rate of your economy, and you’re fine. But with deficits 8-9% of GDP, and only 2% real GDP growth, right now that obviously is not the deal.

It is the interest paid as a factor of revenue available to our government that matters. If that gets too big, it crowds out being able to fund everything else the government is supposed to do in the first place (just ask Greece). Fear of that happening begets higher interest rates. Higher interest rates beget more crowding out. More crowding out begets more fear. And that occurs precisely how a Hemingway character once put it – “gradually and then suddenly.” At which point, they just devalue the dollar, effectively cutting their debts – at the cost of dramatically slashing our entire standard of living overnight. One way or another, it gets paid for.

Right now, with 67% public debt to GDP, our federal government pays ~$230 billion in interest annually, which is about 10% of what it takes in. Even though that debt has doubled in the past several years, that is still rather manageable. But, with ~8-9% annual deficits, we are clearly on the highway to the danger zone.

It’s simple math. Greece thinks it will take in 53 billion euros in tax revenue for 2012 (and good luck with that). Greece has about 330 billion euros in debt. Greece’s market interest rates – the rate at which it would be charged to borrow new funds to pay off having borrowed old ones – are an eye-popping 30% to 110% right now. Being charged annually “just 30%” on 330 billion, when you only have 53 billion to pay for it – and everything else for that matter – doesn’t really work, does it?

Japan has roughly 955 trillion yen in gross debt (US$12.4 trillion). Japanese can fund in the market at rates that range from almost-0% to 1%. Even at a “nose-bleed” 1% interest rate level, it would cost them 9.6 trillion yen a year in effective interest. The Japanese government’s annual general revenue is ~160 trillion yen. So their debt servicing is only ~6% of their revenue, using those numbers. They have far more debt [to GDP] than Greece or us, yet Japan’s burden is a comparatively smaller portion of their ability to fund. Hence, the bond markets have allowed them to enjoy very low interest rates.

But God forbid their interest rates ever go up a few points. If their rates went from 1% to 4%, their debt service would suddenly consume one-quarter of their budget, instead of just one-sixteenth, using my back of the envelope numbers.

The same dilemma we are currently building for ourselves. Our effective interest rate right now is about 2.4% ($230 billion in interest paid in the past twelve months, divided by an average $9.7 trillion debt held by the public in that time). As I wrote, that’s 10% of our current government revenue. But suppose our rates went from 2.4% to 5.4% – a level the effective interest rate was at, about a decade ago, when our debt was only half the size it is now. Now the interest burden suddenly is $540 billion on the current $10 trillion net debt outstanding, which is presently growing $1.3 trillion annually.

Suddenly that’s 24% of government revenue, not “just” 10%. Suddenly just the cost of paying for money already borrowed exceeds all Medicare outlays. After just another three years of $1.3 trillion deficits, a 5.4% interest rate on our subsequent debt would equal the amount of all current Social Security outlays. And what if 5.4% rates were 10%?

To be fair, a 5.4% effective average interest rate would really entail years of much higher interest rates to raise the average blend from 2.4% to 5.4%. But I think you get the point. And the example is not nearly out of the realm of possible, especially since U.S. rates have been 15-20% in the early 1980s – on a much smaller debt burden threat then.

At that point, then what do our politicians [not] do? Who is left to blame that on? Democrats? Republicans? Unwashed Occupiers? Over-zealous Tea Parties? Evil Wall Street bankers? No … just a government of the people, by the people, for the people.

Ultimately, it’s our fault. Yours. Mine. Individually and collectively. Because we let them get away with bad behavior.

So if you want your elected representatives to roll up their sleeves and actually do something about this, make it clear to them that the penalty for doing nothing and seemingly avoiding criticism – holding their breath and hoping this does not blow up in all our faces one day – far outweighs the penalty for doing something bold that does not please all of us, all the time.

Fearing less the consequence of action, than the consequence of inaction is what it means to lead.

As I opened with Simpson-Bowles, I will close with some more of my favorite Hemingway – “If you’re any damned good at all, everything is your own damn fault.”

* I recommend you read the report yourself. In my view, it has several good ideas worth seriously exploring.

Source: U.S. Economy: And The Sun Also Sets