Investors should avoid bonds as the resolution of the fiscal cliff confirms that the White House isn’t serious about spending cuts. When the widely expected deal was completed, it was worse than anyone imagined.
With $41 in tax increases for each $1 in spending cuts, the fiscal cliff was avoided in a way that still managed to add trillions to the deficit. Estimates of the total damage to the economy are still being developed, but it is increasingly likely that the total federal debt will top $20 trillion by the time President Barack Obama leaves office in January 2017.
In eight years, Obama will have doubled the nation’s debt. The Federal Reserve has worked hard to push the average interest rate paid on that debt down by about 1 percent. Lately, Fed efforts have been less effective and if interest rates reverse by only 1 percent, the results could be catastrophic.
The U.S. government paid $451 billion in interest in 2008. Despite the large increase in debt, thanks to the Fed, the amount of interest paid in 2012 was only $360 billion.
If rates rise to the level they were in 2008, the United States would face interest payments of more than $1 trillion a year. The perilous financial position of the United States would force bond markets to demand a higher risk premium and that would lead to even higher rates, potentially putting the United States on the same path that Greece and Spain have been on.
In the long run, there is no free lunch, although Fed Chairman Ben Bernanke did give Obama a chance to run a tab. Markets will eventually call the tab and the United States will have to pay for the debt that Obama has amassed with so few results.
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