Read by dozens, paid for by none, and questioned by most.
A non-economist's non-commissioned view of the economy and the absence of freely determined market prices.
Sunday, May 15, 2016
Why America's Federal Debt is a Clear & Present Danger
There are many themes that the US national debt is 1) stabilizing, 2) not an imminent or even eventual threat, 3) that the Fed has bought so much debt that interest payments won't be a serious concern (as the Fed remits all interest back to the Treasury), & 4) the Fed can buy infinitely more without severe consequences. A recent article exemplifying this theme was posted here.
Below, I'll outline why I believe these theme's (generally accepted by PhD economists, Federal Government, and Wall St.) are likely to result in serious economic, financial, and social destabilization domestically and abroad.
Perspective - Federal Debt vs. GDP The first chart below outlines the growth of debt vs. the growth of annual economic activity in the US. The second chart highlights the change from 2007 to present. The rapid growth in debt not supported by like economic growth (the basis of which to service the debt) should be plain. ***2016 data are estimates based on 2% GDP growth and extrapolating the current growth rate from the present $19.2 trillion debt through the US budget year end.
First, what are Treasury bonds, why does the US issue so many?
A Treasury is a bond whereby "investors" give the US Federal government their dollars for a specified period (from 1 month T-Bills to medium duration Notes up to 30 year Bonds). The "investor" is paid an annual "coupon" (interest payment) on their investment and the initial "investment" is returned to the investor upon the expiration of the bonds term. The government issues and spends these funds because Congress passes laws (promises) absent adequate funding for these laws. To fulfill these promises, the Treasury comes to the rescue to fund what the taxpayer can't or won't.
Who Buys the Debt?
Basically, there are four categories or sources of buying:
The US Public - Primarily institutional buyers which are domestically based; sources like Pensions, Insurers, Banks, Hedge Funds, and a sprinkling of Individuals
Foreigners - US Debt bought and held outside the US...primarily by foreign central banks looking for a home for dollars accumulated through trade surplus'
Intra-governmental Surplus - primarily purchasing using the Social Security surplus
Federal Reserve - Fed "typically" held short duration Bills and Notes through which it affected interest rate policy and it's role of provider of liquidity under "lender of last resort".
Please note, for the chart below, all data is based on January totals...except 2011. 2011 data is based on July as July of '11 was the peak of Chinese Treasury ownership and also the US debt ceiling debate debacle. From August '11 onward, the nature of Treasury buyers changed dramatically.
Total Treasury Debt
The chart below shows total US Treasury debt on select dates and highlights who held how much. Since '01, Foreign held US Treasury debt has grown over 6x's and is the largest class of US debt holders. The 2nd largest holder is the Intra-governmental Surplus which has doubled since '01 despite relative slowing recently. The US Public is the 3rd largest holder and has grown 2.5x's since '01. The smallest of the categories is the Federal Reserve, although it has grown nearly fivefold since '01. However, the Fed has entirely changed it's holdings from near cash, shorter duration Bills & Notes to exclusively longer duration Notes and Bonds...which is to say the Fed holds the majority of the long end of the curve despite "only" holding 13% of total Treasury debt.
And who owned how much (by %) at the different points in time.
The chart below outlines who was buying and how much over each period, in dollars.
The chart below outlines who was buying and how much over each period, by %.
The outcome of the Social Security surplus and the implementation of the "Unified Budget" coupled with the baby boom was a huge source of funding US debt. The Intra-governmental surplus was the home for and source of nearly half of all debt issued up to 2001. However, this source which was mandated to automatically purchase US debt is drying up as boomers retire, hitting SS redemption age en masse. The surplus is in the process of turning to deficit & Intra-governmental surplus' funding government profligacy is fast approaching the end. Which brings us to "marketable" debt...the debt which is sold in the open market. Soon, this will be the only outlet for all new US debt.
The chart below shows the rapid increase in marketable debt, and who owns it. Notable is the rise of foreigners to be the single largest holder presently.
The chart below shows who holds what % of the marketable debt, over time. The growing reliance on foreigners to finance US debt with which Americans are to buy more foreign goods should be plain.
And below, who it was that bought the marketable Treasury debt over different periods. The Fed and foreign buyers simultaneously cease buying since the QE taper was completed.
The cessation of foreign and Fed buying of marketable debt at year end 2014 (which between the two had purchased nearly 75% of all US debt since 2001) was met with yields falling to near record lows?!? On the cessation of 75% of all demand, rates collapsed. This seemingly non-market based reaction was accepted at face value. When the Fed stopped buying via its program of Quantitative Easing, so did foreigners and yet rates have fallen further without any readily identifiable net new bid...And little to no questions about this have been asked?
The post WWII Bretton Woods agreement established that the dollar would be the basis of global trade, and to ensure the US didn't abuse this privilege, the dollar would be convertible to a fixed quantity of gold. In '71, Nixon unilaterally broke the Bretton Woods agreement after the US had suffered a rapid, near two thirds decline in gold holdings to those exchanging the excess flow of dollars for gold. As Nixon said on live TV that fateful '71 Sunday evening, "I have directed Secretary Connally to suspend temporarily (lol) the conversion of the dollar into gold or other assets, except in amounts and conditions determined to be in the interests of monetary stability and in the best interests of the United States". I wonder why the president parsed his words and who it was the president was speaking to when he went out of his way to make clear dollars could still be converted to gold, but only so long as it was deemed in the interests of monetary stability and the US best interests. I digress...lets move on.
But shortly after Nixon's announcement, a new system was put in place, the Petro dollar (whereby the US agreed to "protect and arm" all OPEC nations so long as they maintained their agreement to only sell their oil in US dollars...no matter the nations involved).
Under the Petro dollar arrangement, nations needed a working reserve of US dollars, particularly those nations in need of imported oil. This offered the US a ready made global audience for a rapid increase in the exportation of US dollars. Japan led the way via large dollar surplus' recycled into US Treasury debt. A symbiosis took place whereby the US ran increasingly large trade deficits to buy cheap foreign goods. The US was glad for the ready made Treasury buyers with excess dollars in hand. Japan, China, (and by extension) the BRICS helped to keep their exports "affordable" via devaluing their currencies and purchasing US debt.
The chart below breaks down the foreign buying, by period and type of buyer. Of note is the cessation of purchasing by China and the BRICS since July of 2011 (these are the nations with the largest dollar surplus')...subsequent to '11, this was offset by the buying of the BLICS (Belgium, Luxembourg, Ireland, Cayman Islands, Switzerland...nations that have no dollar surplus' to speak of but do have direct currency swap agreements with the Federal Reserve?!?). However, since the end of QE, nearly all net foreign buying has ceased. Whatever the reason, foreigners are essentially no longer accumulating US debt but the US continues to export more dollars and debt. No way to know for sure, but this could be a trend of de-dollarization on the back of non-stop Yuan, Ruble, etc. currency denominated trade deals reducing the quantity of dollars needed in reserve across the globe?
Still, if the Fed is no longer making any net new purchases via QE, the Intra-Governmental source of funding (excess Social Security income) is drying up, and foreigners appear disinterested...there is only one source left. The US Public??? Where the US Public will come up with $750 billion dollars annually and why will they us them to buy a near zero yielding asset...that's a pretty good question?
So Why Does All This Mean the US is Going Bust???
Four options (none is particularly good):
US Public buys all new Treasury debt (which is supposedly currently happening). Under this scenario, the pensions, insurers, banks, etc. will go bankrupt on a massive mismatch buying the present 1% blended yields vs. 7-8% annual planned appreciation and redemptions. Plus, the redirection of three quarters of a trillion annually away from equities, real estate, the economy should be a little concerning for their valuations?
Hedge funds or "very, very large traders" are buying the new debt but not for yields. Instead, they would be front-running expectations of price appreciation (as yields collapse)...in anticipation of lower rates likely in concert with more QE or a move to outright NIRP?
Treasury rates could rise significantly to incent buying...particularly buying by foreigners but this would result in an interest rate death spiral. A soon to be $20 trillion at a still low (by historical standards) 5% rate would mean $1 trillion in annual interest expenses (primarily sent to foreigners, not the Fed)...and where would America come up with the extra trillion...issue more debt?!?
Outright monetization. Absent all other sources, the Federal Reserve whether via official QE or some unofficial means of backdoor buying maintains the buying at ever lower rates...the most likely outcome is (& may already be) governmental digital counterfeiting or also known as "monetization"!
This habit of making empty promises (laws, spending bills, unfunded mandates) absent means to fulfill them; unwilling to live within our means; unwilling to tax ourselves more or accept lower governmental spending; unwilling to pay a "free-market" interest rate (the stated goal of QE is to drive rates lower); why we won't grow our way out of this (HERE). That only leaves monetization without end. This has never succeeded and is highly unlikely to now. Leaders and sycophants suggesting otherwise should be asked to offer a single time in history something similar has yielded positive results? I can only offer that historically, this route has repeatedly led to ruin. ***All data for this article is publicly available & taken from Federal Reserve, US Treasury, and US Treasury TIC data.