Low interest rates are threatening the U.S. economy more than the sharp fiscal adjustment poised to strike at the end of the year is, said author and financial commentator Peter Schiff.

At the end of the year, the Bush-era tax cuts and other tax breaks and benefits expire at the same time automatic cuts to public spending kick in, a combination known as a fiscal cliff that could send the economy sliding into recession next year if left unchecked by Congress.

Lawmakers have been unwilling to address tax and spending issues in an election year but will likely convene after November’s elections and come to an agreement to steer the country away from the edge of the fiscal cliff, even if such an accord involves temporary measures.

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

The real threat to the economy, however, lies in low interest rates, Schiff noted.

Yields on the benchmark 10-year Treasury note are currently hovering below 2 percent, as investors at home and abroad line up to invest in America.

Sooner or later, those investors are going to demand more for their money, especially considering the rate the country’s debts keep piling up.

Once they do, expect the government to yank money normally bound elsewhere in the economy to service hefty interest on even heftier debt burdens.

“The current national debt is about $16 trillion. This is just the funded portion — the unfunded liabilities of the Treasury, such as Social Security and Medicare, and off-budget items, such as guaranteed mortgages and student loans, loom much larger. Our recent era of unprecedented fiscal irresponsibility means we are throwing an additional $1 trillion or more on the pile every year,” Schiff wrote in a Washington Times commentary.

“The only reason this staggering debt load hasn’t crushed us already is that the Treasury has been able to service it through historically low interest rates (now below 2 percent). These easy terms keep debt-service payments to a relatively manageable $300 billion per year,” Schiff added.

The European debt crisis and China’s cooling growth rates have sent investors scrambling to U.S. Treasurys in search of safe harbor, but that won’t last.

“On the current trajectory, the national debt likely will hit $20 trillion in a few years. If, by that time, interest rates were to return to 5 percent (a low rate by postwar standards) interest payments on the debt could run around $1 trillion per year,” Schiff wrote.

“Such a sum would represent almost 40 percent of total current federal revenues and likely would constitute the single largest line item in the federal budget. A balance sheet so constructed would create an immediate fiscal crisis in the United States.”
Meanwhile, the economy would slow and crimp tax revenues, exacerbating the government’s dilemma as it seeks to finance public spending and rising debt burdens with less income.

“By foolishly borrowing so heavily when interest rates are low, our government is driving us toward this cliff with its eyes firmly glued to the rearview mirror,” Schiff said.

“Most economists downplay debt-servicing concerns with assertions that we have entered a new era of permanently low interest rates. This is a dangerously naive idea.”

The European Central Bank (ECB) is reportedly close to announcing plans to buy sovereign bonds from countries like Spain and Italy to lower borrowing costs there and ease the debt crisis.

Such a move, if it came it pass, could entice investors out of the safe haven of U.S. Treasurys and toward higher-yielding asset classes, including European debt and stocks worldwide, which could pressure U.S. Treasury prices downward, setting the stage for higher interest rates down the road as the U.S. government seeks to entice investors back.

ECB President Mario Draghi said recently he would be comfortable buying government debt with three years to maturity, which could spark demand for risk.

“There are expectations in the market that the ECB will announce something,” said Luca Jellinek, head of European interest-rate strategy at Credit Agricole Corporate & Investment Bank in London, according to Bloomberg.

“That perhaps underpins risk sentiment and weakens demand for high-grade government bonds.”

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation