The United States Federal Reserve Board and its central banking allies have furiously battled the fierce financial forest fires of the ongoing worldwide economic crisis that emerged five years ago. As the disaster developed and traveled across the financial landscape, their accommodative approaches evolved. Although central bank methods have varied to some extent, they generally have included deluges of money printing and pinning nominal policy rates (Federal Funds and so forth) close to the ground. These central bank actions not only helped to spark and sustain economic recovery, but also bought politicians time to solve, or at least substantially mitigate, troubling fiscal deficit problems.

Nevertheless, debt levels and deficit spending in America and many other countries generally remain substantial. Efforts targeted to assist recovery partly explain the size of gaping fiscal deficits of recent years. Yet in America and many other nations, they arguably reflect and are structurally sustained by a culture of entitlement. This culture, although not universally shared, extends across the economic spectrum. In any event, government budget deficits in the United States are not a new phenomenon.

However, even without specifically concentrating on its long term fiscal challenges, the US probably is much closer these days to a big debt problem than many believe. Focusing on the near term US government deficit and debt situation in the context of several other nations highlights the danger.

Everyone knows of the Eurozone (Euro Area) crisis. America’s fiscal balances are much more in deficit over the 2008-2017 span than the overall Euro Area’s.

However, from the general government gross debt viewpoint, and especially with a view on 2012 and thereafter, the US problem looks at least as fearsome as the overall Eurozone difficulty. First, the US level exceeds the European height every year, from 2008 out to 2017. Second, the IMF indicates a fall for the Euro Area after 2013, but not for the US.

Inflation is not the only potential source of higher interest rates. The lesson of the Eurozone sovereign debt crisis shows that government interest rates can climb sharply in crisis nations (Greece, Portugal, Ireland, Spain, Italy) even if inflation is moderate. Ability to pay debts (and borrow money), not just inflation levels and trends, matters for interest rate levels (and sovereign credit spread differentials). A badly stretched debtor may have to pay up to find money, right? So rising government interest rates in some cases may reflect a dreadful debt crisis, not a sunny economic recovery.

Closely nearing or reaching a point of no return on the US fiscal front therefore probably would be reflected by a spike in UST yields. The 10 year US Treasury note offers a benchmark for US yield watchers. In recent years, rising government interest rates often have been roughly tied to ascending US stocks (S+P 500), not just an economic recovery. If US equity benchmarks such as the S+P 500 start to decline significantly, and roughly “alongside” the increase in yields (thereby breaking from the guideline UST/stock relationship of recent times), that probably would confirm the existence of a debt crisis.

FOLLOW THE LINK BELOW to download this market essay as a PDF file.
Financial Forest Fires- US Government Debt (8-15-12)
US Treasury 10 Year Note Chart (8-15-12)