US Interest Rates At A Record Low – But This Is Only Because Europe Is A Much Bigger Risk – American Fiscal Predicament Pretty Awful – Is There Enough Time To Avoid The End Of The Year “Fiscal Cliff”?

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By Paolo von Schirach

July 12, 2012

WASHINGTON – US 10 year Treasury Bonds are well below 2%. This historic low caused a dramatic decline in lending rates. Amazingly, interest rates on 30 year mortgages are now at 3.56%, the lowest they have have been since the 1950s. In ordinary circumstances, these unheard of low interest rates for government securities would exist only in countries with super solid finances and an impeccable fiscal record.

Horrible US fiscal outlook

But this is not at all the case in America. In fact just the opposite is true. The American fiscal outlook is bad to terrible. Annual deficits exceed $ 1 trillion, while total debt is now beyond $ 16 trillion, an astronomic figure. We borrow 40 cents of every dollar Washington spends.

Still, all this is not because the country is broke. This is due mostly to a complete lack of political agreement between Democrats and Republicans on the best way to reconcile entitlement reform with tax reform and other spending cuts, while preserving viable welfare programs for the truly needy, for seniors and for retirees.

As long as this ideologically driven deadlock persists, there will be no comprehensive spending and tax reform. The gap between revenue and spending will continue, the deficit will stay high and the national debt will keep piling up.

Why such low interest rates?

This being the case, then why the extremely low interest rates on US debt? Why aren’t we going the way of Spain and Italy, with 10 year bond rates above 6%? Well, believe it or not, America’s debt is coveted today, (hence the low interest rates), precisely because Spain, Italy, Greece, Portugal, Ireland and many others are doing so poorly, at the same time undermining the credibility of the entire Eurozone. Given persistent fears of a possible European monetary catastrophe, investors worldwide look at US bonds as the best refuge. America is still perceived as a solid country, or at least better than many alternatives. And the US dollar is still the world’s reserve currency.

Complacency makes things worse

But while the US can look at this long period of incredibly low interest rates due to the turmoil in Europe as a true blessing for a government that has to borrow vast sums just to keep going, I believe that this reprieve is in fact bad, because it allows policy makers to pretend that there is no crisis. This complacency allows them to postpone the day of reckoning. Today, America is like a terminally ill patient under massive sedation who feels no pain and therefore mistakenly believes he is doing alright.

The truth is that these historically low interest rates for US Government securities have not been “earned” trough sound fiscal policies. We get them because so many weaker countries are doing so much worse. As Bill Gross of PIMCO put it, America is the cleanest one in a pile of dirty shirts. I would not call this a compliment paid to Washington’s fiscal management by one of the smartest bonds trader in the world.

A solution is possible

Sure enough America can fix this fiscal mess. It is not beyond our reach. But now we are waiting for national elections, and all serious negotiations are off. So, wait until after the November vote. Still, without any agreement on fiscal reform by year end, current law prescribes huge mandatory spending cuts and tax increases that would have a horrible impact on the country. Without action, we are indeed headed towards a “Fiscal Cliff”.

Only a short time left to avoid the “Fiscal Cliff”

One would hope that Washington would not allow this to happen. Well, who knows how irresponsible our leaders can be. Based on their record so far, a lot. And consider the time constraints: assuming no action before the elections, there will be just a little more than a month to take care of this huge fiscal and taxation mess between the November vote and the end of the year deadline. May be enough time to concoct “something” and avert falling into the “Cliff”; but sadly not enough time to come up with a wise, credible and long lasting plan.

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