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Debt's Impact Could Be Worse If Interest Rates Rise

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Debt's Impact Could Be Worse If Interest Rates Rise

Economy

Debt's Impact Could Be Worse If Interest Rates Rise

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MARY LOUISE KELLY, host:

Debt is also the issue of the day here in Washington. Lawmakers are still trying to hammer out a deal to raise the ceiling on the amount of debt the government can take on. But economists say the country will need to reduce the amount of money it's borrowing because of all the debt we've accumulated could get a lot more painful in the future.

NPR's Chris Arnold reports.

CHRIS ARNOLD: There's obviously all this attention right now on the ballooning size of the national debt. But this is kind of surprising: Short-term interest rates are so low at the moment that the government can borrow that money almost for free.

Professor PETE KYLE (University of Maryland): Right now, with money as cheap as it is, the deficit is not a drag at all.

ARNOLD: Pete Kyle is a finance professor at the University of Maryland.

Prof. KYLE: But if you look at what's coming in the future, the potential drag that you see in the future is a really big problem.

ARNOLD: This has everything to do with interest rates. With rates so low, it's kind of like the government is floating trillions of dollars in debt on one of those zero percent credit card offers that you get in the mail. Those are great while they're at zero percent. But if you don't pay the card off before the rate resets and shoots way up, you can be in big trouble really quickly.

Prof. KYLE: That's exactly the problem the federal government's facing. So the big danger to the U.S. economy going forward is that interest rates go up.

ARNOLD: Especially if they go up faster than the rate of inflation. Now, it's not like there's some date set in stone where the government will suddenly have to pay higher interest rates. But most analysts say that rates won't stay this low forever. And you don't have to go back too far in history to see interest rates that were much, much higher. Take 1980.

(Soundbite of CBS broadcast)

Unidentified Woman: CBS News, this is "News Break." After that inflation report, most major banks raised their prime lending rate to 17 and three-quarters percent.

ARNOLD: But rates don't have to spike that high to cause big problems. That's because with the size of the national debt right now at nearly $15 trillion, any increase will start siphoning mind-boggling amounts of money out of the Treasury.

Scott Simon is a top bond investor at Pimco.

Mr. SCOTT SIMON (Pimco): When you're $15 trillion in debt, one percent on that's $150 billion. So the cost is real.

ARNOLD: And Pete Kyle says most analysts expect that short-term rates will start rising.

Prof. KYLE: Interest rates will, starting about a year from now, will rise about percentage point a year, and they'll do that for several years.

ARNOLD: So five years from now, Kyle says just the interest on the current level of national debt could cost...

Prof. KYLE: Seven hundred and fifty billion dollars a year.

ARNOLD: Seven hundred and fifty billion. That's a lot bridges not getting built or Medicare not getting paid. But for now, the economy has to make it past this August 2nd deadline for raising the debt ceiling. And whatever their thoughts on the deficit, just about nobody in the business world wants to see lawmakers in Washington force the U.S. Treasury to default.

David Kotok is chief economist at Cumberland Advisors.

Mr. DAVID KOTOK (Cumberland Advisors): The Treasury note is the single most important security. It cannot default. It would be a horror story globally. The politics of this are insane.

ARNOLD: Kotok says a default could set off a terrible chain of events. Interest rates could spike right away, not a couple years down the road. Banks could go insolvent. The housing market might collapse.

Mr. KOTOK: You run the risk in a default by the United States of a catastrophic meltdown like we saw when Lehman Brothers failed or AIG failed - only much larger.

ARNOLD: So far the stock market seems to be betting, though, that lawmakers in the end won't take that risk and they will work out a deal to avoid a default.

Chris Arnold, NPR News.

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