Regarding raising interest rates to 18 or 20%, how could we do this? We have so much debt outstanding would this create a balance of payments risk (ie we don’t take in enough revenue to pay our debt service)?
Yes and no. Basically the treasuries yield a ‘fixed’ rate of return upon issue. This is done by discounting the face value by the rate of return and the time over which the return applies. If after issue, the yield on new issues goes up, the existing outstanding issues will still yield the same amount. What happens is that the face value of existing treasuries will now drop to compensate for the change in yields. An Q&D(quick and dirty) example. We purchase 2 10 year Tbills, one day apart. The first Tbill is at 5%. The rates jumped the next day and it was issued at 7%. The price for the first $10K Tbill will be about $6139. The second will be about $5083. After the rate jump, you will not be able to resell the first treasury for its initial purchase price. If you wanted to sell both treasuries on the third day, they would both go for about $5083 each, meaning that you would take a $1056 capital loss on the first treasury. (I am not going to get into yield curves at this point.)
What the increase does mean, is that further deficit spending will be more expensive, but it does not adversely affect existing payments. If Congress can get its act together and control spending (ha, ha.. yeah right), the shift in interest rates would allow the fed to buy back treasuries at a face value less than what they were issued at. Of course, deficit spending would have to cease to do this.. Or the fed could increase the Money Supply(M0) to fund the repurchase (which has other nasty repercussions).
