All the financial articles I've seen regarding the tremendous debt of the US government and many countries in Europe all focus on the debt to GDP ratio. The US is approaching a 100% ratio, Japan is sitting at 200% and most European nations are sitting somewhere in the 75-125% range. I don't think this means a whole lot to most people as it's hard to relate this value to something similar in your own life.
When you look at the debt to income ratio I believe you get a much better idea of how bad things are in a way the average person can relate to. The idea of how much you earn versus how much you owe is more meaningful to look at. Let me do a simple example.
Let's say you have a job that pays 100K a year and the only debt you have is your home mortgage that sits at a nice round 200K. In this simple example you have a debt to income ratio of two. If you have a fixed rate loan at 5% then you would pay 10K a year in interest on that loan which would take up only 10% of your total income leaving you 90% for everything else. This is a pretty reasonable situation that is sustainable long term as long as the individual doesn't overspend on other things.
Let's say the same person with the same 100K a year income buys a larger house and ends up with a 400K mortgage. In this example you have a debt to income ratio of 4. The bank realizes that at a fixed 5% the interest payment would be 20K a year and take up 20% of your income making the home essentially unaffordable. What the bank does is offer you an adjustable rate mortgage that starts out at 2.5% for the first 3 years and varies after that. You end up with the same 10K per year interest payment but get to live in a much larger house. What going to happen in three years is too far off to worry about.
This is the essence of the sub prime real estate bubble that crashed the housing market and pushed millions of homes into foreclosure.
The Federal government of the US finds itself stuck in the greatest sub prime bubble in the history of the world. We have amassed a tremendous debt that we are only able to afford because we are able to get an extremely low sub prime interest rate on this loan. The government has an income of a bit more than 2 trillion a year and currently pays a bit more that 200 billion in interest on its debt. The actual debt owed is now in excess of 14 trillion dollars leaving us with a debt to income ratio of about 7. That would be like you with your 100K income having a mortgage of about 700K.
To make matters worse, in order to pay our other bills besides the interest on our debt we need to borrow massive amounts of money each year. In our example of a 100K income, this would be like having to borrow an additional 60K a year just to pay the bills. If this were your personal financial situation you would most likely be scared out of your mind and in the process of figuring out how you are going to change your lifestyle. You obviously could not continue to borrow more than half your annual income every year and expect the bank to keep loaning you money. You also could not expect the bank to keep the sub prime interest rate you're paying so low for much longer. Any rational person in this situation would know that very soon major changes would need to be made or bankruptcy could occur.
If we look at Japan, they are at the point now that we will find ourselves in 10 to 20 years. They need to borrow every year more money than they collect in tax revenue. The only reason this is possible is that the Japanese people save a large portion of their income and the majority of their savings goes into Japanese treasury bonds. The Japanese are paying a second tax by having all their savings go to treasury bonds that pay nearly no interest and that the government has no chance of ever repaying. As soon as the Japanese people don't have enough extra money to "invest" in treasury bonds the government will be forced to look for foreign investors who will demand much higher interest rates. Their day of reckoning is rapidly approaching as their population is old and getting older meaning a smaller workforce of tax payers and savers.
The people that congress puts in charge of studying these types of things have concluded that by 2020 the amount we pay in interest on our debt will rise from 10% to around 30% of all tax revenue and this is the best case scenario. Due to the forecasted growth of our economy and assumed substantial tax increases our debt to income ratio will stay in the 7 range but that again is the best case scenario. Looking beyond 2020 to 2030 and 2040, these same people forecast that interest payments alone will consume the majority of all tax revenue.
What we must understand is that these forecasts are meaningless as the grim reality of the situation will not allow us to continue this way past 2020. Our ability to borrow more money will at some point come to an end and at that point we will only be able to spend as much as we earn and the majority of what we earn will go to paying interest on our debt. When we can no longer borrow huge sums of money each month we will not be able to send Social Security checks, pay Medicare claims or pay a soldiers salary. Anyone collecting a Federal pension will not get a check, defense contractors will find themselves not getting paid for the work they do.
Does it make sense to wait until the last possible moment, when the system simply runs out of money to be lent to make the hard choices. By then the cuts will be sudden and drastic, the effects will be seen everywhere. Right now we still have 90% of over 2 trillion dollars to fund the necessary functions of the Federal government and we need to figure out a way to live within this budget. This is not a Republican vs Democrat, Socialist vs Capitalist argument. Without the ability to borrow as much as we need at nearly zero interest our system would fail.
If we don't see a dramatic change to bring about a balanced budget in short order you need to prepare yourself for the very real consequences of government failure within this decade. If your job or your pension or your medical benefits are in any way tied to the Federal government you need to be prepared for those benefits to cease. Think all the way back to 2002 and imagine if someone had told you this is what you can expect before 2011. For me at least, 2002 doesn't seem that long ago and I haven't done anything in these past 9 years to prepare for life without the massive life support of the Federal government.