The incredible cost of higher interest rates

August 23, 2016

In 1995, the total debt of our government was an impressive $4.9 trillion. It has, of course, become much more impressive since. Gross government debt at the end of 2015 was nearly four times higher, $18.1 trillion.

But that’s not the truly magical part of the federal debt story. In 1995, the net interest cost of government debt was $232 billion. Twenty years later, even with debt nearly four times higher, the net interest cost was slightly lower, $223 billion.

Yes, the interest cost of government debt today is less than it was 20 years ago. That’s nothing short of amazing. No doubt some would argue that the U.S. Treasury has “saved” the $9 billion difference.

We all know how this was done. It was quite simple, really. Lower interest rates mean lower interest costs.

So our government has avoided a major problem by doing its best to reduce interest rates.

You can follow the month-by-month reduction in government interest costs in a handy online tool from the U.S. Treasury, treasurydirect.gov.

It shows that the average cost of government debt declined from 6.537 percent in January 2000 to 2.267 percent this June. Consider the impact of inflation, and the Treasury will be returning less purchasing power to lenders than it received. Debt is free.

Equally important, our government hasn’t been the only beneficiary. Anyone who had a debt that could be refinanced benefited. It was great for homeowners. Refinancing home mortgages has become a hefty industry. Today, refi gurus suggest you can benefit anytime you can cut your mortgage interest rate by 75 basis points, or 0.75 percent.

Borrowing new money has been pretty good, too. Today you can borrow to buy a new car and pay less than 2 percent a year for five years. You might not get that rate at a bank, but you can certainly get it at a credit union.

Even at today’s low inflation rate, borrowed money is basically free when measured by purchasing power returned to the lender.

Lower interest rates were pretty good for asset holders, too.

They had the effect of raising asset prices. We’ve had a bull market in bonds. Stocks haven’t done so badly either - provided you have a strong stomach for ups and downs. And home values have risen to levels close to the insanity of 2006. What’s not to like?

All in all, it seems lower interest rates have been a good thing. Solvent seniors suffer, of course, but let’s get real. They’re old. Besides, complaining about having no yield on your savings is a bit like complaining that you have no shoes to a gathering of people who have no feet.

In fact, lower interest rates for governments are what the old Veg-O-Matic was to everyone’s kitchen. It was the tool no one could live without because it could do everything. So it should come as no surprise that governments around the world have discovered the wonders of low interest rates.

The trick is getting back to “normal,” since people and institutions with savings aren’t going to accept the depreciation of their money forever.

So let’s ask a rude question: What would a return to normal do?

If the average cost of government debt returned to 2000 levels, interest expense would nearly triple to $643 billion.

To be sure, returning to normal interest rates wouldn’t happen overnight. But the prospect is for years, perhaps decades, of rising interest payments crowding out other government spending. Rising interest costs will consume increases in federal revenue.

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