Is The Interest Rate Death Spiral Finally Starting?

The yield on Italy’s 10-year bond is up by about 100 basis points from its 2018 low. Meanwhile, its government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, forcing it to borrow even more money, and so on until this “interest rate death spiral” becomes fatal.

It would already be fatal, if not for the European Central Bank’s willingness to buy Italy’s bonds at extremely favorable prices (i.e., very low interest rates). But now the ECB is promising to stop doing that, which leaves Italy in the early stages of a very negative feedback loop.

Not our problem, you say? Italy is irrelevant to everyone including most Italians, so its imminent financial crisis is no more important than Venezuela’s.

Fair enough. Let’s move closer to home and start the story over:

The yield on US 10-year Treasury paper is up almost 100 basis points since last September. Meanwhile, the government continues to borrow money and roll over its existing debt. But now it has to do so at ever-higher interest rates, which means it has to pay more interest, which means its deficits are rising, which means it has to borrow even more money at higher interest rates, and so on until this “interest rate death spiral” becomes fatal.

It would already be fatal if not for the Federal Reserve’s willingness to buy Treasury bonds at extremely favorable prices (i.e., very low interest rates). But now the Fed is promising to stop doing that, which leaves the US in the early stages of a very negative feedback loop.

Here’s what the US government’s interest payments would be under different average interest rates:

Note that the highest rate used in this table – 6% – is about average for the two decades prior to 2000. So it only seems extreme in today’s era of monetary experimentation. We’ll get back there, one of these days.

Except that we won’t. An annual interest bill of 1+ trillion dollars would send the deficit – which is projected exceed a trillion without a meaningful rise in interest rates – above $2 trillion. And – since new interest will accrue on each year’s new borrowing – the current 21 trillion of US government debt would grow by around 10% a year in this scenario, kicking the process of higher rates producing higher deficits into overdrive. This impossible-to-hide acceleration will in turn produce extreme responses from governments and/or markets, including but not limited to spiking inflation, plunging bond prices, capital controls, martial law and a global monetary reset.

Italy will probably get there first, which allows Americans to view our future by looking across the Atlantic. So you see it does matter.

And remember, this scenario involves only central government debt, which is cumulatively dwarfed by private sector debts, state and local unfunded pension liabilities, emerging market external dollar debts, and bank derivatives. And all of these things are vulnerable, one way or another, to rising interest rates, which means the interest rate death spiral, when it kicks into high gear, will be something for the history books.

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