Here is the basic pattern of the interest rate “death spiral.” A country’s interest rates increase, making it harder to make the basic payments on its debt. This make lenders even more nervous, so they increase rates even more, making it even harder to service the debt, which makes lenders raise rates again, and so on. You want an idea of how bad this can get and how fast? Check out this grim little graph, which shows interest rates on Greek debt spiking from a little over 3% to 30% in about two years. That’s what a real sovereign debt crisis looks like, and you can see how Greece had no way out without intervention from a larger and wealthier country like Germany.
This describes what the crisis looks like, but not what drives it. What drives the crisis is the inability to stop borrowing or to pay down the debt because massive, chronic borrowing is built into the system. It is built into the system because the country has adopted a massive welfare state and bloated government employment. Government has grown so big that the private economy can no longer realistically be taxed enough to support it. Nor can the size of government be reduced significantly, because so much of the economy has become dependent on it that any reduction in welfare payments or in the rolls of government employees causes a massive increase in unemployment and deepens the recession. So the only alternative is to keep borrowing at high levels, year after year-and when the government can no longer do that, the country faces, not a mere recession, but economic collapse. When massive spending cuts are then forced onto a country, millions of people feel as if they have been suddenly cut off for no reason, and they are driven into the streets in rage.
That is what the Eurocrisis is about, and under Obama, America is setting itself up for exactly the same kind of death spiral…
Here is how the debt bomb goes off. Big entitlement spending that can’t be cut drives larger and larger borrowing. When investors finally realize this is unsustainable and rates go up, so much of our debt is short-term that we suffer a rapid increase in borrowing costs, which begin to overwhelm everything else, stretching an already overwhelmed budget even farther. We start borrowing money just to pay interest on money we borrowed earlier. As investors realize this, rates go up farther, making interest payments go up faster. One moment we’re suffering under the illusion that we can keep borrowing money for free forever, and the next moment we see interest on our debt become the largest single item in the budget. But we can’t change it because it’s all built into the system. We have to keep borrowing to sustain the entitlement state.