March 4, 2021

Bucks: The Federal Debt: When Compound Interest Is Crushing

Carl Richards

The showdown over increasing the federal debt limit got me thinking about the power of compound interest. It’s always been one of the most powerful forces in the financial universe. And in the case of the debt ceiling, it appears that compound interest has the potential to become a crushing enemy.

Some people fear that the United States will lose its AAA credit-rating or even default temporarily, potentially increasing how much it costs the government to borrow money. According to the Congressional Budget Office:

…a 4-percentage-point across-the-board increase in interest rates would raise federal interest payments next year by about $100 billion; if those higher rates persisted, net interest costs in 2015 would be nearly double the roughly $460 billion that the C.B.O. currently projects for that year.

Think about that for a minute. If those worst-case-scenario interest rates came to pass and persisted, we’d be approaching a trillion dollars in interest payments per year. That’s what compound interest looks like when it’s working against you.

On a personal scale, you get a taste of it every month if you get careless with credit cards. Take a look at a bill. For every month you carry a balance, there’s a minimum payment required.

Many people only pay the minimum, not realizing that compound interest could make that $3,000 television cost way more than that and take over a decade to pay off. And that assumes you don’t add any additional charges to the balance.

New rules require that credit card companies include a section on each statement that shows just how long it will take to pay off the balance if you only make the minimum payment. Do yourself a favor and pay attention to the numbers. What you owe will only compound over time, and paying the minimum just digs the hole that much faster.

J. Reuben Clark, an undersecretary of state for President Coolidge, noted a long time ago that, interest on debt “never sleeps nor sickens nor dies… Once in debt, interest is your companion every minute of the day and night; you cannot shun it or slip away from it; you cannot dismiss it; it yields neither to entreaties, demands, or orders; and whenever you get in its way or cross its course or fail to meet its demands, it crushes you.”

It also gets in the way of achieving our goals. Last week, one reader commented that having a zero balance on your credit card was almost as good as saving money. There is some truth to that because every dollar we spend on interest is one less dollar that can be saved for the future.

Now it becomes a question of how to make compound interest work for you instead of working against you.

Next week we’ll talk about the power of compound interest and the end of a long period of savings. In the meantime, what have you done to protect yourself from getting crushed by interest?

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