Monday, November 23, 2009
The New York Times has a good essay on debt:
But that happy situation, aided by ultralow interest rates, may not last much longer.
Treasury officials now face a trifecta of headaches: a mountain of new debt, a balloon of short-term borrowings that come due in the months ahead, and interest rates that are sure to climb back to normal as soon as the Federal Reserve decides that the emergency has passed.
Even as Treasury officials are racing to lock in today’s low rates by exchanging short-term borrowings for long-term bonds, the government faces a payment shock similar to those that sent legions of overstretched homeowners into default on their mortgages.
With the national debt now topping $12 trillion, the White House estimates that the government’s tab for servicing the debt will exceed $700 billion a year in 2019, up from $202 billion this year, even if annual budget deficits shrink drastically. Other forecasters say the figure could be much higher.
In concrete terms, an additional $500 billion a year in interest expense would total more than the combined federal budgets this year for education, energy, homeland security and the wars in Iraq and Afghanistan.
The potential for rapidly escalating interest payouts is just one of the wrenching challenges facing the United States after decades of living beyond its means....There is little doubt that the United States’ long-term budget crisis is becoming too big to postpone.
Americans now have to climb out of two deep holes: as debt-loaded consumers, whose personal wealth sank along with housing and stock prices; and as taxpayers, whose government debt has almost doubled in the last two years alone, just as costs tied to benefits for retiring baby boomers are set to explode.
The competing demands could deepen political battles over the size and role of the government, the trade-offs between taxes and spending, the choices between helping older generations versus younger ones, and the bottom-line questions about who should ultimately shoulder the burden.
The Times continues:
“The government is on teaser rates,” said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates lower deficits. “We’re taking out a huge mortgage right now, but we won’t feel the pain until later”...
The problem, many analysts say, is that record government deficits have arrived just as the long-feared explosion begins in spending on benefits under Medicare and Social Security
The current low rates on the country’s debt were caused by temporary factors that are already beginning to fade. One factor was the economic crisis itself, which caused panicked investors around the world to plow their money into the comparative safety of Treasury bills and notes. Even though the United States was the epicenter of the global crisis, investors viewed Treasury securities as the least dangerous place to park their money.
On top of that, the Fed used almost every tool in its arsenal to push interest rates down even further. It cut the overnight federal funds rate, the rate at which banks lend reserves to one another, to almost zero. And to reduce longer-term rates, it bought more than $1.5 trillion worth of Treasury bonds and government-guaranteed securities linked to mortgages...
The Fed, meanwhile, is already halting its efforts at tamping down long-term interest rates. Fed officials ended their $300 billion program to buy up Treasury bonds last month, and they have announced plans to stop buying mortgage-backed securities by the end of next March.
Eventually, though probably not until at least mid-2010, the Fed will also start raising its benchmark interest rate back to more historically normal levels...
Even a small increase in interest rates has a big impact. An increase of one percentage point in the Treasury’s average cost of borrowing would cost American taxpayers an extra $80 billion this year — about equal to the combined budgets of the Department of Energy and the Department of Education...
The White House estimates that the government will have to borrow about $3.5 trillion more over the next three years. On top of that, the Treasury has to refinance, or roll over, a huge amount of short-term debt that was issued during the financial crisis. Treasury officials estimate that about 36 percent of the government’s marketable debt — about $1.6 trillion — is coming due in the months ahead.
As Karl Denninger has repeatedly pointed out, we are on an unsustainable track guaranteed to lead to a debt crisis. Denninger posts the following chart to make his point:
And as Tyler Durden noted on November 1st:
As the assets on the US balance sheet become increasingly long-dated, courtesy of QE, and locking in record low rates, US liabilities in turn have shortened their duration to a record level. Almost $3 trillion in US debt will have to be rolled by the end of 2010. If realistic inflation expectations are any indication, all hopes of getting comparable interest terms on these securities once refinancing time rolls around, will be promptly dashed (we are not saying inflation is inevitable, even with QE 2.0 around the corner). Yet for all who claim inflation is a good thing, the one security that will be hit the most and the fastest will be precisely the T-bill universe, once all the curve steepeners already in place unwind very, very quickly. The result would be a major spike in interest expense payments by the government. The chart below presents the historical annual interest expense on all USTs by year. 2009 will be the first year in which the interest expense alone will be over half a trillion dollars (Zero Hedge estimates).
The concern is that even as the US debt, which as of Friday was at $11,868,457,477,911.94, and looks like it will hit the $12.104 trillion limit within a few weeks, continues to skyrocket, the interest expense paid on holdings will continue creeping ever higher. Keep in mind, at September 30, the average interest rate on Bills was a historically low 0.347%, and Notes yielded a QE-facilitated 3.043%. With the Fed out, can China and US retail investors support this record low interest at a time when UST supply keeps coming and coming?
And as the Times points out, America is competing with other countries to sell debt:
The United States will not be the only government competing to refinance huge debt. Japan, Germany, Britain and other industrialized countries have even higher government debt loads, measured as a share of their gross domestic product, and they too borrowed heavily to combat the financial crisis and economic downturn. As the global economy recovers and businesses raise capital to finance their growth, all that new government debt is likely to put more upward pressure on interest rates.Paul Krugman disagrees, believing that debt is a "phantom menace". But this is not because Krugman is a liberal. Government economists in the Reagan, Bush and Obama administrations have all believed pretty much the same thing: deficits don't matter.
But many experts disagree:
- The St. Louis Federal Reserve Bank posted a paper entitled "Is The United States Bankrupt?". The paper provides the following answer: "The United States is going broke"
- People seem to think the government has money," "said former U.S. Comptroller General David Walker. "The government doesn't have any money"
- The United States Department of the Treasury and the Office of Management and Budget published a report stating that the U.S. cannot grow our way out of the government's liabilities, that the liabilities are quickly growing, and that failing to take drastic and immediate action would lead to very bad consequences (the report was written in 2006)
- Nouriel Roubini writes:
Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won't solve the debt overhang problem (Dr. Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn).
- The International Monetary Fund - which oversees third-world economies - is so concerned about the solvency of the U.S. economy that, during the Bush administration, it started conducting a complete audit of the whole US financial system. The IMF previously only audited banana republics (then again ...)
- Société Générale published a report titled "Worst-case debt scenario", in which the bank's asset team said state rescue packages over the last year have merely transferred private liabilities onto sagging sovereign shoulders, creating a fresh set of problems. "As yet, nobody can say with any certainty whether we have in fact escaped the prospect of a global economic collapse," said the 68-page report, headed by asset chief Daniel Fermon. It is an exploration of the dangers, not a forecast. The underlying debt burden is greater than it was after the Second World War, when nominal levels looked similar. Aging populations will make it harder to erode debt through growth. "High public debt looks entirely unsustainable in the long run. We have almost reached a point of no return for government debt," it said. The bank said the current crisis displays "compelling similarities" with Japan during its Lost Decade (or two), with a big difference: Japan was able to stay afloat by exporting into a robust global economy and by letting the yen fall. It is not possible for half the world to pursue this strategy at the same time.
- The American Enterprise Institute for Public Policy Research (AEI) published a paper indicating that “by all relevant debt indicators, the US fiscal scenario will soon approximate the economic scenario for countries on the verge of a sovereign debt default.”
Obama told Fox news that the United States' climbing national debt could drag the country into a double-dip recession
And see this.