Updated: ZeroHedge has a more pessimistic debt model

I still think my presentation has more value for predicting a debt crisis, but ZeroHedge offers up a model with different variables and arrives at roughly the same conclusion. ZeroHedge's model is more pessimistic than mine, which is why I believe mine is valuable, as I'll explain below.

ZeroHedge's even worse forecast for the debt can be seen in "The Magic Of Compounding" - The Impact Of 1% Change In Rates On Total 2022 US Debt
Our assumptions are also painfully simple:

i) grow 2012 year end GDP of ~$16 trillion at what is now widely accepted as the 'New Normal' 1.5% growth rate (this can be easily adjusted in the model);

ii) assume the primary deficit is a conservative and generous 6% of GDP because America will never, repeat never, address the true cause of soaring deficits: i.e., spending, which will only grow up in direct proportion with demographics but as we said, we are being generous (also adjustable), and

iii) sensitize for 3 interest rate scenarios: 2% blended cash interest; 3% blended cash interest and 5% blended cash interest.
I assumed a 3% rate of increase in the debt along with GDP. ZeroHedge uses the exact same interest rate break up as mine (+1% and a jump to 5%), except they start with 2% instead of the current 2.6%.

Below is my chart that is based on interest costs as a percentage of government revenues. My chart is even more painfully simple; it extends government revenue growth, spending and therefore debt at 3% into the future. Then what I do is apply a static interest rate. In my scenario, you can see what happens to changes in interest rates based on this scenario—at any point in time. In other words, my chart is best read as a sudden "Return of the Bond Vigilantes" scenario, because there is no compounding in my model. The total debt is the same no matter the three interest interest rates.

ZeroHedge calculates debt/GDP ratios and also total debt. Here's their debt-to-GDP chart:

In the chart below, I take ZeroHedge's GDP forecast and compare it to my debt growth model. As you can see, my model presents three forecasts that work off of the most positive debt scenarios from ZeroHedge.

Even in the most optimistic scenarios, a rise in interest rates to 3.5% blows the budget up and a rise to 5% would cause a sovereign debt crisis. Things are far worse than most realize.

Below are my previous posts on this model.
America's debt problem
America's debt problem grows by $600 billion

UPDATE: Here are the debt assumptions behind my model, in graph form:

As you can see it is quite simplistic and yet arrives at the same conclusion: game over. The biggest flaw/point of contention in the model is the size of the deficit. Most forecast the deficit shrinking over time. My model has it staying around 8%, while ZeroHedge has it falling to 6% of GDP. I created my forecast after the fiscal cliff bill was passed. Unless the debt ceiling debate causes Congress to suddenly grow a spine, I believe it will prove relatively accurate with larger deficits from a recession and smaller ones during recovery.

If I slowly take deficits down to 3% of GDP in 2022 (about 0.5 percent per year), the total debt is running at about $25 trillion in 2022, $5 trillion below my forecast. That gives a debt to GDP of 138% (using ZeroHedge's forecast), at which point an interest rate of 4% would cost the government $1 trillion in interest payments. In my previous posts, I've said that these numbers could be met with stronger GDP growth or spending cuts, but both are optimistic today. Social Security is already in the red, forcing government to cut spending in order to hold the deficit level. Obamacare taxes really hit in 2014 with the penalties and that's when the economy will slow considerably, likely sinking into recession later in 2013. Medicaid costs will surge as people forego insurance, pay the penalty and sign up for Medicaid.

In the end, even if the model is pessimistic and growth comes through, there will need to be serious cuts to entitlements and defense now in order to avoid a crisis. The U.S. is on an unsustainable path and any negative shock could force it into crisis. My model implicitly assumes some type of bailout or extra-ordinary cost that is not part of most forecasts.

If everything goes right with no bailouts, no recession, the U.S. will come out at a point in the future where debts are in control. Debt to GDP would be very high, but if the annual deficit fell to 3% of GDP then considerable growth or spending cuts were made to make room for rising interest payments. The U.S. can't get there via tax rates because the slowing of the economy would create a recession and increase the odds of a crisis.

Optimists can say my model is pessimistic, but they need nothing bad to happen in the next ten years. I'm betting that socionomics is still working in favor of the pessimists.

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