Stephen Roach thinks that long-term interest rates in the US are nearly as low as they will get, primarily because everyone in the US seems to be borrowing rather than saving:
[T]he US saving outlook has just taken a worrisome turn for the worse. That wouldn’t be so bad if America started from a position of strength on the saving front. But, of course, that is not the case. America’s net national saving rate has averaged only 1.5% since early 2002 — a record low and literally one-fifth the 40-year average of 7.5% recorded over the 1960 to 2000 time period. Moreover — and here’s the kicker for the bond market — in looking out over the next few years, the outlook is now deteriorating for all three major components of domestic US saving — for consumers, the government sector, and Corporate America.
…But there is a new source of concern: Courtesy of Hurricane Katrina, a saving-short US economy may be entering a new era of vulnerability. The outlook for US fiscal policy is especially worrisome in this regard. The political repercussions of this devastating storm cannot be minimized. With the impacts underscoring some of America’s most glaring disparities — economic, social, and ethnic — politicians of both major parties are opting to spend their way out of the blame game. For a federal budget deficit that was supposed to come in at -2.4% of GDP in fiscal 2006, a conservative estimate of post-Katrina spending could easily push that figure into the -3.25% to -3.5% range — virtually identical to peak cyclical shortfalls hit in 2003-04. With margins of slack narrowing, the timing of this fiscal impetus could not be any worse. Moreover, it is occurring in a context when private sector saving is at a record low — effectively putting the US in the uncomfortable position of having to ask its foreign creditors to pick up the tab for repair and reconstruction of the Gulf Coast.
The point that Roach makes here is an important one: if we now expect a budget deficit of 3.5% of GDP in 2006, with a growing economy, what can we expect when the next recession strikes – perhaps as soon as 2006 or 2007? Recessions always cause a significant widening in budget deficits… but since we will be starting the next recession with a deficit of 3.5% of GDP, that means that we could soon be looking at budget deficits of 5% of GDP or more. Not a pleasant prospect.