Payback time? NYT looks at the "Debt Bomb"

"What a good country or a good squirrel should be doing is stashing away nuts for the winter," bond expert Bill Gross said in last Monday's New York Times. "The United States is not only not saving nuts, it's eating the ones left over from the last winter."

Gross, founder of Pimco, the world's largest and most influential bond-investment firm, is quoted in a front-page Times' story: "Wave of Debt Payments Facing U.S. Government" - the first article in the newspaper's series, "The Debt Bomb."

Excerpts:

Even as Treasury officials are racing to lock in today's low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House estimates that the government's tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.

The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means....

So far, the demand for Treasury securities from investors and other governments around the world has remained strong enough to hold down the interest rates that the United States must offer to sell them. Indeed, the government paid less interest on its debt this year than in 2008, even though it added almost $2 trillion in debt....

[But g]lobal investors are [now starting to shift] money into riskier investments like stocks and corporate bonds, and they have been pouring money into fast-growing countries like Brazil and China.

The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month.... Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels....

This month, the Treasury Department's private-sector advisory committee on debt management warned of the risks ahead.

"Inflation, higher interest rate and rollover [i.e., refinancing] risk should be the primary concerns," declared the Treasury Borrowing Advisory Committee, a group of market experts that provide guidance to the government, on Nov. 4.

"Clever debt management strategy," the group said, "can't completely substitute for prudent fiscal policy."

We didn't get to this point overnight, of course. In fact, the fuse on the "debt bomb" has been burning for so many years now (Larry Burkett was writing about this topic nearly two decades ago) that sometimes it seems as though it's not anything to be concerned about.

But as the Times' story notes: "[T]here is little doubt that the United States' long-term budget crisis is becoming too big to postpone." Let's hope so. Postponing it is what got us to where we are now (along with lots of overspending, of course).

A nicely done set of graphics accompanying the Times' pieces notes that the U.S. government (and other governments now in similar debt situations) have four options - not mutually exclusive, but some definitely don't work well together:

1. Raise taxes/cut services: This approach makes for unhappy voters, plus tax increases tend to inhibit economic growth, which can make the longer-term situation worse.
2. Inflation: The idea is to erode the value of the debt by inflating the money supply. But such an approach also drives up living costs and undermines the value of savings.
3. Default: The failure of the U.S. government to meet its obligations would likely cause a financial panic.
4. Economic growth: A growing economy produces more revenue and cuts the government's need to borrow. As growth increases employment, it also reduces outlays for certain social services.

Number 4 is certainly the best option, but unfortunately, many politicians seem stymied about how to foster growth. Indeed, they often develop policies that work against growth.

So while a hefty dose of number 4 would be the happiest outcome, it seems more likely - based on what we're seeing from the White House and Congress - that we're going to get mostly a mix of 1 and 2.

Meanwhile, the fuse on the debt bomb is getting shorter.
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Joseph Slife is a contributing author and editor for SMI. Visit www.soundmindinvesting.com to learn more.