Baker has gone through that as well. From the same linky as above:

However, there is an even more simple and completely painless path to a lower debt-to-GDP ratio. The price of long-term bonds rises when interest rates fall. The price of these bonds falls when interest rates rise.

This latter point is important. Currently, interest rates are at near post-war lows. We have issued 10-year Treasury bonds at interest rates close to 1.5 percent and 30-year bonds at interest rates of 2.75 percent. The Congressional Budget Office, along with other official forecasters, project that interest rates will rise sharply over the next few years.

If interest rates rise as projected, then the price of these long-term bonds fall sharply. For example, if the interest rate on 30-year bonds rises to 6 percent by 2016, then the price of a 30-year bond issued at 2.75 percent in 2012 will have fallen by more than 40 percent. This means that if the government issued $100bn in bonds at the low 2012 rate, it could buy them back for less than $60bn in 2016, instantly eliminating $40bn of government debt. (Allan Sloan made this point in a slightly different context.)

The government can follow this practice of buying up large number of bonds issued at low interest rates to eliminate much of the debt it has incurred. Although the government's debt-to-GDP ratio is reaching heights not seen since the years just after World War II, the ratio of interest on the debt-to-GDP is at post-World War II lows.

This means that when interest rates rise, there will be a sharp decline in the market value of government debt, allowing for massive amounts of debt reduction simply by buying back debt at the discounted value that the CBO is effectively projecting. We should have little problem shaving 15-20 percentage points off our debt-to-GDP ratio through such purchases, hitting whatever target the deficit hawks have decided is necessary.

Of course, this is ridiculous. Buying back debt at discounted prices will not change our interest burden at all. But we live in a world where the folks deciding economic policy have now decided that the debt-to-GDP ratio will be the new guidepost for economic policy.


IOW, don't look at a bare number and think that it means doom. Just because interest rates rise, that doesn't mean doom and gloom. Interest rates will rise as the economy improves. An improving economy increases tax revenue and decreases support payments. It makes the debt burden easier to handle, not more difficult.

FWIW.

Cheers,
Scott.