Federal Debt Is Looking Like a Bubble

As anyone who has tried to get a mortgage recently can tell you, interest rates are at historic lows. The interest on government securities even fell below zero last week, meaning that investors had to pay the government for the privilege of owning U.S. debt.

The problem is that this situation will not last forever, and interest rates are likely to head higher once the economic crisis has passed. According to a report in the New York Times, the White House estimates that by the year 2019, interest on the national debt will be $700 billion, up from $200 billion this year.

That’s a $500 billion difference—or larger than the budgets of the departments of education, energy, homeland security, and the cost of the wars in Iraq and Afghanistan combined.

The villain is a long-expected increase in the cost of Social Security and Medicare benefits as the baby-boomer generation reaches age 65, swamping the government with extra costs.

“What a good country or a good squirrel should be doing is stashing away nuts for the winter,” William H. Gross, managing director of the Pimco Group, the world’s largest bond investment firm, told the Times. “The United States is not only not saving nuts, it’s eating the ones left over from last winter.”

The U.S. government ran up a $1.4 trillion deficit in 2009, thanks to spending on the stimulus package and bailouts of big banks and Detroit automakers. That’s 25 percent of GDP, the highest percentage since World War II.

The national debt is projected to reach $17.1 trillion by 2019, according to estimates in the Wall Street Journal. The paper says the budget deficit will remain above $1 trillion in 10 years, even though the economic situation will have improved dramatically.

Several factors have helped contribute to the current low levels of interest rates. The Federal Reserve has kept its overnight rate—the rate at which banks lend to each other—at near zero for the past 12 months. That could change as early as the middle of next year: As the economy starts to improve, the Fed will start to raise interest rates.

“The government is on teaser rates,” Robert Bixby, executive director of the Concord Coalition, told the Times. "We’re taking out a huge mortgage right now, but we won’t feel the pain until later.”

In addition, the Fed has been buying U.S. Treasury bills and mortgage-backed securities, a process called quantitative easing, that helps keep interest rates low. But the Fed ended its purchase of Treasuries last month and will stop buying mortgage-backed securities in March.

The dire predictions leave the U.S. with two uncomfortable outcomes. Either the government starts cutting benefits—such as raising the retirement age at which baby boomers can claim the benefits of Social Security and Medicare—or the government will have to ramp up taxes on those still working.

Neither outcome is likely to win politicians any votes.