England has been put on negative watch for its debt rating. Bill Gross said yesterday that it's not unthinkable that the US could lose its AAA rating. I think the bond market is looking at the mountain of debt that will have to be somehow sold, and wondering where such a colossal sum will come from. Where do you find $10 trillion in the next 10 years for US debt?

And that's just for US government debt. Five trillion for new global debt in the next 2 years? In a deleveraged world? How much will the other countries need? What about money needed for businesses, mortgages, credit cards and so on?

If you add $10 trillion to the current $11.3 trillion (including Social Security trust funds, etc.), that totals $21 trillion in 2019. Let's be generous and suggest that interest rates will only be an average of 5%. That would be an interest-rate expense of over $1 trillion. That's 25% of projected revenues and 20% of expected expenses. And that assumes you have nominal growth of over 4% for the next 10 years. If growth is less, tax revenues will be less. It also assumes massive tax increases from carbon credits.

The Paradox of Deficits

I think the bond market is looking a few years down the road and saying that $1-trillion deficits are simply not capable of being financed. And if the debt is monetized, then inflation is going to become a very serious issue.

When you run deficits that are 4-8% or more than nominal GDP, at some point, things simply back up. Can we ride along for a few years? Certainly. Japan is getting ready to see its debt-to-GDP ratio rise to almost 200%. But everybody can't do it all at once.

Call it the Paradox of Deficits. We've been running a large trade deficit in the US for years because the people (China, Japan and the Middle East) who wanted to sell us "stuff" were kind enough to turn around and invest the money in our bonds. This, in turn, created Greenspan's conundrum, as it helped keep down US (and global) interest rates. Combine that with a massive increase in leverage and a few bubbles, and we now arrive at a true crisis.

Deficits aren't necessarily a bad thing if kept in check and if restraint is shown. But everyone cannot run deficits at the same time. If we don't buy $700 billion in goods, then that money cannot be recycled back to our debt. It's that simple.

(Sidebar: And now, China and Brazil are moving to do their trades in their own currencies rather than dollars. Very smart on their part.)