In yesterday's post I discussed my views on the stupidity of every major nation's defined-benefit pension and/or healthcare schemes over the past 120 years, beginning with Germany under Bismarck.
Doug Dachille, a fixed-income maven and occasional guest on CNBC, has articulated several times that overly-indebted governments have a choice between whom they will disappoint/stiff.
They can default on their bonds, being legal debt obligations, in order to favor citizens who vote for members of the government. Or they can pay their bonds and enact combinations of more/higher taxes and benefits cuts for citizens.
A Wall Street Journal editorial in Wednesday's edition echoed Dachille by pointing out that there is no real need for a default, regardless of what happens by August 2nd or, potentially, the date on which Congress recesses for the summer, August 8th.
That is because there is more than sufficient tax revenue every month to pay the nation's debt interest.
Therefore, to Dachille's point, thanks to badly-designed and overly-optimistic social welfare programs passed by less-than-stellar intellects in Congress throughout the last eighty years, the more logical solution to America's spending and debt problems is to cut benefits in these programs.
Yesterday, on CNBC's noontime program, David Stockman was enlisted to push the network's liberal agenda. A perennial favorite of the network's due to his combination of serving in Reagan's administration, but actually being a big-tax-and-spend liberal, Stockman didn't fail his hosts. He immediately decried the current debt limit debate as really about deficits, which, of course, require new and higher taxes to close them.
He then bemoaned, several times, that Senate Democrats had regrettably and inexplicably thrown in the towel on demanding new taxes.
Apparently Stockman isn't familiar with Hauser's Law, or the fact that federal tax revenues as a percentage of US GDP average 18% over the long term, no matter what the composition of tax rates and bases.
Amazing as it may be, Stockman, too, confuses tax rates with tax revenues. He evidently continues to fail to understand that lower rates, which accommodate economic growth and higher GDPs, lead to higher total tax revenues on lower tax rates.
On Greta Van Sustern's Fox News program Wednesday night, GOP House Budget Chairman Paul Ryan discussed the current debt limit debate, noting, in answer to a question from the program's host, that various national debt estimates don't typically include the off-budget programs such as Social Security, Medicare and Medicaid. Further, he explained, those aren't like bonds which have been issued, and must be retired. The terms, conditions and costs of the entitlement programs can be changed and, thus, do not represent formal, fixed claims on the federal Treasury.
While some US states, such as Illinois, California, Michigan and New Jersey, pre-Christie, may flirt with defaults, exhibit government denial of their inability to tax their way out of their fiscal nightmares, and, ultimately, appeal to the federal government to bail them out, the US government has no ultimate guarantor.
It doesn't take a genius to see that fixed debt obligations in the form of bonds will have to be honored and serviced.
Given that tax receipts can't be expected to rise above about 18% of US GDP, the growth of which has been anemic due to recent newly-increased levels of federal spending and regulation, the only remaining variable in the equation to eventually shrink the US federal deficit has to be spending.
Quaint Washington games like automatic 7%-per-year baselines budget increases have to be ended. Eventually, Social Security, Medicare, Medicaid and all other off-budget programs should be brought on-budget, to reflect a consolidated balance sheet of federal liabilities.
Perhaps only then will most voters finally understand that they have allowed their elected federal officials, for some eight decades, to enact promised social benefit programs which will simply never be payable on a sustained basis.
One only has to revisit the Greek situation, with the many stories and jokes about the short working careers, easy work rules and lavish retirement benefits, to understand that much of the developed world's economies have the same tough challenge ahead- to shrink their once-promised federal-provided social benefits back to affordable levels. Probably involving, at some point, individual defined contribution accounts paid annually out of government receipts, so that there will never be generationally-shifted debts for the consumption of social welfare programs.
A chance remark in a recent Wall Street Journal editorial noted that, just now, as many governments need to borrow heavily to plug budget deficits, many of said governments are finding it convenient to excoriate debt rating agencies and dismiss requirements for using their ratings.
Regardless of how badly S&P, Moodys and Fitch mis-rated mortgage-back structured finance instruments earlier in this decade, or how badly they may err in rating sovereign debt, that chance comment caused me to speculate that global economic growth and debt may be about to reach a tipping point together.
Specifically, with so much borrowing occurring for so much deficit spending among so many nations, while growth among the developed economies has slowed, thanks to ill-advised taxation, spending and regulatory policies, we may well see a sustained period of lower global demand as a result.
The reason for this would be as follows. As governments realize that promised social benefits must be trimmed, they spark a realization among their citizens that savings must rise to offset diminished future government-provided retirement and healthcare subsidies. With government spending reduced, and private-sector spending among consumers reduced to save for future retirement and medical spending, we may well witness a global shrinkage of demand as the final consequence of the deleveraging which began with the financial crisis of 2008.
To me, it seems obvious that after nearly a century of unaffordable social benefit schemes, many governments are now having to rectify those unsustainable promises, cut them, and trigger heretofore unexpected and unseen changes in savings and consumption patterns among consumers across many developed economies. Such economic behavioral changes among consumers may last for decades, and result in permanent changes in savings and consumption rates and, for years, if not decades, slower national economic growth rates.
For, having realized that promised pension and healthcare benefits simply won't be forthcoming as promised by many governments over past decades, individuals will return to pre-mid-twentieth century habits of high savings rates and markedly lower consumption, to prepare for self-financed medical and retirement needs. I believe that will drive discontinuous changes in individual economic behavior not seen in the lifetimes of most economists currently engaged in modeling, estimating and forecasting such behaviors.
Showing posts with label National Debt. Show all posts
Showing posts with label National Debt. Show all posts
Friday, July 29, 2011
Wednesday, July 27, 2011
The Debt Limit & Downgrade- So What?
Occasionally, CNBC co-host Gary Kaminsky will say something simple and insightful when others miss the point. He did so earlier this week on David Faber's noontime program.
When asked about the potential impact of a rating agency downgrade of US debt, Kaminsky said that it didn't really matter, because nobody believed the US is a AAA credit anymore, and the downgrade is already priced in. Not because of the debt limit debate, but because of the nation's profligacy.
I believe Kaminsky is entirely correct and echoes my sentiments in this post from earlier this month,
"Druckenmiller contends that no serious change at all in federal spending and disposition regarding its habits would be the worst outcome. And if the GOP rushes to capitulate after a government shutdown, there won't be such change. Obama will declare political victory, many Tea Party voters will be disgusted with the GOP.
But if Obama faces a GOP House whose members are willing to force a shutdown and, then, after it is clear there won't be capitulation, an ordered payment of federal obligations, while some functions are shuttered, everyone- global investors, voters, onlookers- will understand that things have changed.
In the meantime, the US would have lost its AAA rating. No matter which party gained relatively greater power among Congress and the White House in 2012, a return to borrowing and spending for new programs would no longer be an option. Interest rates would be too high on Treasuries to borrow much more money, if investors would even lend it. Slow economic growth and joblessness would make higher taxes on anyone a non-starter.
In short, a default now will bring forward what I believe would be the eventual outcome of political business as usual in Washington, which will continue without a default.
Whether it's this group of Republicans, or another, after a brief return to Democratic control of the House, Senate, and Oval Office, and the final orgy of unaffordable deficit spending, it will likely now take some catastrophic event such as a credit rating downgrade and default to wake up Washington politicians to what is understood by many American voters and most global investors, to wit, no small change in American federal government fiscal policy will suffice any longer."
Just this morning, I heard a fund manager from Loomis Sayles say essentially the same thing.
What seems to escape the grasp of many pundits, and certainly Congress and the president, is that America doesn't have an inalienable right to a AAA credit rating, even as it debauches its currency and has spent, for most of 80 years, more each year than it receives in tax receipts.
Ironically, sophisticated capital markets combined with a dearth of investment alternatives post-WWII to leave the dollar and US Treasuries in the position of becoming the world's reserve currency.
Much like Rome after the fall of Carthage, the US has been, in the long run, ill-served by the absence of competitors to it as a reserve currency and general free world economic superpower. We've gradually picked up momentum, post-WWII, spending and promising to spend, on entitlements, consistently more than tax receipts were funding. It took about three-quarters of a century, but we've finally exhausted the investment appetites of the rest of the world for our securities.
On recent fiscal policy course, the US has become a discredited government. If the Fed weren't artificially pegging rates so low, and monetizing Treasuries' borrowings to the great extent that it is, does anyone really believe interest rates on Treasuries would be so low, or that the dollar wouldn't be even cheaper?
An official rating cut from AAA for America is warranted, debt limit agreement, or not.
One pundit predicted a partisan 'blame game' among federal elected officials.
Well, American voters need only look in the mirror for whom to blame. They consciously elected and re-elected generally inept spendthrifts since 1932, then wonder why the country has amassed so much net external debt.
It's time for Americans to wake up to the consequences of their poor political choices for the last eight decades.
And when the rating downgrade happens, the resulting increased funding costs will help put a stop to excessive spending and bad tax policies, only from outside, uncontrollable forces, rather than internal, political ones.
When asked about the potential impact of a rating agency downgrade of US debt, Kaminsky said that it didn't really matter, because nobody believed the US is a AAA credit anymore, and the downgrade is already priced in. Not because of the debt limit debate, but because of the nation's profligacy.
I believe Kaminsky is entirely correct and echoes my sentiments in this post from earlier this month,
"Druckenmiller contends that no serious change at all in federal spending and disposition regarding its habits would be the worst outcome. And if the GOP rushes to capitulate after a government shutdown, there won't be such change. Obama will declare political victory, many Tea Party voters will be disgusted with the GOP.
But if Obama faces a GOP House whose members are willing to force a shutdown and, then, after it is clear there won't be capitulation, an ordered payment of federal obligations, while some functions are shuttered, everyone- global investors, voters, onlookers- will understand that things have changed.
In the meantime, the US would have lost its AAA rating. No matter which party gained relatively greater power among Congress and the White House in 2012, a return to borrowing and spending for new programs would no longer be an option. Interest rates would be too high on Treasuries to borrow much more money, if investors would even lend it. Slow economic growth and joblessness would make higher taxes on anyone a non-starter.
In short, a default now will bring forward what I believe would be the eventual outcome of political business as usual in Washington, which will continue without a default.
Whether it's this group of Republicans, or another, after a brief return to Democratic control of the House, Senate, and Oval Office, and the final orgy of unaffordable deficit spending, it will likely now take some catastrophic event such as a credit rating downgrade and default to wake up Washington politicians to what is understood by many American voters and most global investors, to wit, no small change in American federal government fiscal policy will suffice any longer."
Just this morning, I heard a fund manager from Loomis Sayles say essentially the same thing.
What seems to escape the grasp of many pundits, and certainly Congress and the president, is that America doesn't have an inalienable right to a AAA credit rating, even as it debauches its currency and has spent, for most of 80 years, more each year than it receives in tax receipts.
Ironically, sophisticated capital markets combined with a dearth of investment alternatives post-WWII to leave the dollar and US Treasuries in the position of becoming the world's reserve currency.
Much like Rome after the fall of Carthage, the US has been, in the long run, ill-served by the absence of competitors to it as a reserve currency and general free world economic superpower. We've gradually picked up momentum, post-WWII, spending and promising to spend, on entitlements, consistently more than tax receipts were funding. It took about three-quarters of a century, but we've finally exhausted the investment appetites of the rest of the world for our securities.
On recent fiscal policy course, the US has become a discredited government. If the Fed weren't artificially pegging rates so low, and monetizing Treasuries' borrowings to the great extent that it is, does anyone really believe interest rates on Treasuries would be so low, or that the dollar wouldn't be even cheaper?
An official rating cut from AAA for America is warranted, debt limit agreement, or not.
One pundit predicted a partisan 'blame game' among federal elected officials.
Well, American voters need only look in the mirror for whom to blame. They consciously elected and re-elected generally inept spendthrifts since 1932, then wonder why the country has amassed so much net external debt.
It's time for Americans to wake up to the consequences of their poor political choices for the last eight decades.
And when the rating downgrade happens, the resulting increased funding costs will help put a stop to excessive spending and bad tax policies, only from outside, uncontrollable forces, rather than internal, political ones.
Friday, May 20, 2011
More Idiocy From Jamie Dimon
I heard Bloomberg report this morning that Chase's CEO, Jamie Dimon, was excoriating Congress for taking the national debt limit seriously.
In a commencement speech in Colorado, Dimon castigated Congress for risking default and all that he believes will follow.
But, as I noted in this recent post discussing Stanley Druckenmiller's interview in the Wall Street Journal last weekend, real bond traders have a different view.
Last I looked, Dimon's formative years were spent carrying Sandy Weill's bags for a living. I don't believe Dimon was ever celebrated for running a successful government bond trading operation.
Druckenmiller, on the other hand, is known for successfully trading government debt. And he disagrees completely with Dimon's opinions, dispensed, such as they are, from 20,000 feet.
Ever since I worked closely with the CEO and Chairman at Chase Manhattan Bank, thanks to my mentor, Gerry Weiss, and with his helpful explanations, I learned how often such executives become pompous and self-important, pronouncing on topics about which they actually know little, or nothing, simply because of the title behind their names.
So, who would you believe? Druckenmiller, who's made a career in investing in governments, or Dimon, who's made a career as a financial services apparatchik and bureaucrat?
In a commencement speech in Colorado, Dimon castigated Congress for risking default and all that he believes will follow.
But, as I noted in this recent post discussing Stanley Druckenmiller's interview in the Wall Street Journal last weekend, real bond traders have a different view.
Last I looked, Dimon's formative years were spent carrying Sandy Weill's bags for a living. I don't believe Dimon was ever celebrated for running a successful government bond trading operation.
Druckenmiller, on the other hand, is known for successfully trading government debt. And he disagrees completely with Dimon's opinions, dispensed, such as they are, from 20,000 feet.
Ever since I worked closely with the CEO and Chairman at Chase Manhattan Bank, thanks to my mentor, Gerry Weiss, and with his helpful explanations, I learned how often such executives become pompous and self-important, pronouncing on topics about which they actually know little, or nothing, simply because of the title behind their names.
So, who would you believe? Druckenmiller, who's made a career in investing in governments, or Dimon, who's made a career as a financial services apparatchik and bureaucrat?
Tuesday, May 17, 2011
Stanley Druckenmiller's Debt Limit/Default Remarks
It has been frustrating reading and listening to so much misinformation and disinformation from crony capitalists and politicians regarding the soon-to-be-reached federal debt limit and the maneuvering between the House Republicans and the administration regarding it.
So I was elated to read this weekend's interview in the Wall Street Journal. Stanley Druckenmiller, the interview's subject, was candid about the debt limit situation. It seems he shares the viewpoints I've articulated on this subject over on my companion political blog.
Druckenmiller distills his view of the situation in these passages from the interview,
"'A financial crisis is surely going to happen as big or bigger than the one we had in 2008 if we continue to behave the way we're behaving," says Stanley Druckenmiller, the legendary investor and onetime fund manager for George Soros. Is this another warning from Wall Street that Congress must immediately raise the federal debt limit to prevent the end of civilization?
No—Mr. Druckenmiller has heard enough of such "clamor and hyperbole." The grave danger he sees is that politicians might give the government authority to borrow beyond the current limit of $14.3 trillion without any conditions to control spending.
"I think technical default would be horrible," he says from the 24th floor of his midtown Manhattan office, "but I don't think it's going to be the end of the world. It's not going to be catastrophic. What's going to be catastrophic is if we don't solve the real problem," meaning Washington's spending addiction.
"Here are your two options: piece of paper number one—let's just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don't know, six days, eight days, 15 days, but I know I'm going to get it. There's not a doubt in my mind that it's not going to pay, but it's going to be delayed. But in exchange for that, let's suppose I know I'm going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured," he says.
Then there's "piece of paper number two," he says, under a scenario in which the debt limit is quickly raised to avoid any possible disruption in payments. "I don't have to wait six, eight, or 10 days for one of my many payments over 10 years. I get it on time. But we're going to continue to pile up trillions of dollars of debt and I may have a Greek situation on my hands in six or seven years. Now as an owner, which piece of paper do I want to own? To me it's a no-brainer. It's piece of paper number one." "
This has been my view for some time. Merely raising the debt limit is to announce that absolutely nothing has changed. It has to be combined with spending cuts, and a slight delay in a few interest payments, if that even occurs, is a small price to pay for the federal government being forced to begin to aggressively cut its out-of-control spending.
Few things are as convincing as empirical evidence, and on that score, Druckenmiller corrects what passes for that, incorrectly, from the mouths of some pundits and politicians,
"Mr. Druckenmiller had already recognized that the government had embarked on a long-term march to financial ruin. So he publicly opposed the hysterical warnings from financial eminences, similar to those we hear today. He recalls that then-Secretary of the Treasury Robert Rubin warned that if the political stand-off forced the government to delay a debt payment, the Treasury bond market would be impaired for 20 years.
"Excuse me? Russia had a real default and two or three years later they had all-time low interest rates," says Mr. Druckenmiller. In the future, he says, "People aren't going to wonder whether 20 years ago we delayed an interest payment for six days. They're going to wonder whether we got our house in order."
Mr. Druckenmiller is puzzled that so many financial commentators see the possible failure to raise the debt ceiling as more serious than the possibility that the government will accumulate too much debt. "I'm just flabbergasted that we're getting all this commentary about catastrophic consequences, including from the chairman of the Federal Reserve, about this situation but none of these guys bothered to write letters or whatever about the real situation which is we're piling up trillions of dollars of debt."
He's particularly puzzled that Mr. Geithner and others keep arguing that spending shouldn't be cut, and yet the White House has ruled out reform of future entitlement liabilities—the one spending category Mr. Druckenmiller says you can cut without any near-term impact on the economy."
On the subject of current interest rates and the bond market, Druckenmiller is refreshingly candid,
"Some have argued that since investors are still willing to lend to the Treasury at very low rates, the government's financial future can't really be that bad. "Complete nonsense," Mr. Druckenmiller responds. "It's not a free market. It's not a clean market." The Federal Reserve is doing much of the buying of Treasury bonds lately through its "quantitative easing" (QE) program, he points out. "The market isn't saying anything about the future. It's saying there's a phony buyer of $19 billion of Treasurys a week."
Warming to the topic, he asks, "When do you generally get action from governments? When their bond market blows up." But that isn't happening now, he says, because the Fed is "aiding and abetting" the politicians' "reckless behavior." "
Finally, he echoes my own thoughts on Ryan's budget,
"Mr. Druckenmiller says he's "a registered independent" but says he admires New Jersey Gov. Chris Christie for the way he has explained that the state has to reform its benefit plans if it is going to be able to take care of retired government workers. He argues that the same case needs to be made nationally. "We don't have a choice between Paul Ryan's plan and the current plan, because the current plan is a mirage. . . . That money is not going to be there." "
But so long as politicians and crony capitalists pretend current programs and spending can be sustained, we're going to test the real bond markets at some point. And then the result is unlikely to be pretty or painless.
So I was elated to read this weekend's interview in the Wall Street Journal. Stanley Druckenmiller, the interview's subject, was candid about the debt limit situation. It seems he shares the viewpoints I've articulated on this subject over on my companion political blog.
Druckenmiller distills his view of the situation in these passages from the interview,
"'A financial crisis is surely going to happen as big or bigger than the one we had in 2008 if we continue to behave the way we're behaving," says Stanley Druckenmiller, the legendary investor and onetime fund manager for George Soros. Is this another warning from Wall Street that Congress must immediately raise the federal debt limit to prevent the end of civilization?
No—Mr. Druckenmiller has heard enough of such "clamor and hyperbole." The grave danger he sees is that politicians might give the government authority to borrow beyond the current limit of $14.3 trillion without any conditions to control spending.
"I think technical default would be horrible," he says from the 24th floor of his midtown Manhattan office, "but I don't think it's going to be the end of the world. It's not going to be catastrophic. What's going to be catastrophic is if we don't solve the real problem," meaning Washington's spending addiction.
"Here are your two options: piece of paper number one—let's just call it a 10-year Treasury. So I own this piece of paper. I get an income stream obviously over 10 years . . . and one of my interest payments is going to be delayed, I don't know, six days, eight days, 15 days, but I know I'm going to get it. There's not a doubt in my mind that it's not going to pay, but it's going to be delayed. But in exchange for that, let's suppose I know I'm going to get massive cuts in entitlements and the government is going to get their house in order so my payments seven, eight, nine, 10 years out are much more assured," he says.
Then there's "piece of paper number two," he says, under a scenario in which the debt limit is quickly raised to avoid any possible disruption in payments. "I don't have to wait six, eight, or 10 days for one of my many payments over 10 years. I get it on time. But we're going to continue to pile up trillions of dollars of debt and I may have a Greek situation on my hands in six or seven years. Now as an owner, which piece of paper do I want to own? To me it's a no-brainer. It's piece of paper number one." "
This has been my view for some time. Merely raising the debt limit is to announce that absolutely nothing has changed. It has to be combined with spending cuts, and a slight delay in a few interest payments, if that even occurs, is a small price to pay for the federal government being forced to begin to aggressively cut its out-of-control spending.
Few things are as convincing as empirical evidence, and on that score, Druckenmiller corrects what passes for that, incorrectly, from the mouths of some pundits and politicians,
"Mr. Druckenmiller had already recognized that the government had embarked on a long-term march to financial ruin. So he publicly opposed the hysterical warnings from financial eminences, similar to those we hear today. He recalls that then-Secretary of the Treasury Robert Rubin warned that if the political stand-off forced the government to delay a debt payment, the Treasury bond market would be impaired for 20 years.
"Excuse me? Russia had a real default and two or three years later they had all-time low interest rates," says Mr. Druckenmiller. In the future, he says, "People aren't going to wonder whether 20 years ago we delayed an interest payment for six days. They're going to wonder whether we got our house in order."
Mr. Druckenmiller is puzzled that so many financial commentators see the possible failure to raise the debt ceiling as more serious than the possibility that the government will accumulate too much debt. "I'm just flabbergasted that we're getting all this commentary about catastrophic consequences, including from the chairman of the Federal Reserve, about this situation but none of these guys bothered to write letters or whatever about the real situation which is we're piling up trillions of dollars of debt."
He's particularly puzzled that Mr. Geithner and others keep arguing that spending shouldn't be cut, and yet the White House has ruled out reform of future entitlement liabilities—the one spending category Mr. Druckenmiller says you can cut without any near-term impact on the economy."
On the subject of current interest rates and the bond market, Druckenmiller is refreshingly candid,
"Some have argued that since investors are still willing to lend to the Treasury at very low rates, the government's financial future can't really be that bad. "Complete nonsense," Mr. Druckenmiller responds. "It's not a free market. It's not a clean market." The Federal Reserve is doing much of the buying of Treasury bonds lately through its "quantitative easing" (QE) program, he points out. "The market isn't saying anything about the future. It's saying there's a phony buyer of $19 billion of Treasurys a week."
Warming to the topic, he asks, "When do you generally get action from governments? When their bond market blows up." But that isn't happening now, he says, because the Fed is "aiding and abetting" the politicians' "reckless behavior." "
Finally, he echoes my own thoughts on Ryan's budget,
"Mr. Druckenmiller says he's "a registered independent" but says he admires New Jersey Gov. Chris Christie for the way he has explained that the state has to reform its benefit plans if it is going to be able to take care of retired government workers. He argues that the same case needs to be made nationally. "We don't have a choice between Paul Ryan's plan and the current plan, because the current plan is a mirage. . . . That money is not going to be there." "
But so long as politicians and crony capitalists pretend current programs and spending can be sustained, we're going to test the real bond markets at some point. And then the result is unlikely to be pretty or painless.
Tuesday, May 03, 2011
John Cochrane On Inflation, Treasuries & US Spending
John Cochrane of the University of Chicago's Booth School wrote an editorial in Thursday's Wall Street Journal explaining why the US federal budget for 2025, seemingly so far off in the future, matters today.
Cochrane periodically pens editorials in the Journal, and they are always well-written and -reasoned. This one was no exception.
Early on, he associated current returns on a 30-year Treasury of 4.5% with a real 2% return, implying a long term inflation rate lower than 2.5%. With that rather risky bet as a background, he noted that such a belief of low inflation means,
"you have to bet they will solve the 2025 deficit. If you decide that the government will just keep kicking the deficit can down the road, sell your 30-year Treasuries. Sell fast, before everyone else does- because if we all try to sell, we just drive down the price and long-term interest rates rise."
Cochrane went on to chide the government for making the same mistake that Bear Stearns and Lehman did in 2008, i.e., fund excessively short-term for alleged reasons of lower cost, ignoring the risks of funding drying up when refinancing is undertaken. He warns,
"It is cheap precisely because it is dangerous."
So true, because the lender's view of short-term finance is that you aren't liable for the longer-term default. You only have to bet that the borrower, in this case the US, will manage to remain solvent for another few quarters or a year.
I won't go into Cochrane's comments on budget cuts, tax rates, etc., because they are more political in nature, and this is my business blog. However, he closes with these passages,
"The challenge is whether we will accept a vaguely rational tax system and a set of entitlements that protect the vulnerable without bankrupting the Treasury. It's not rocket science.
But we don't have much time. The bond market won't wait. The budget and debt problems will be much harder to solve if long-term interest rates spike, the dollar falls further, and inflation breaks out."
That last line caught my attention after I reread the piece following my reading of the weekend Journal's lead interview with Smithfield Foods CEO C. Larry Pope. Here are some of the passages from that piece,
"Mr. Pope is the chief executive officer of Smithfield Foods Inc., the world's largest pork processor and hog producer by volume. He doesn't mince words when it comes to rapidly rising food prices. The 56-year-old accountant by training has been in the business for more than three decades, and he warns that the higher costs may be here to stay.
It's also a business under enormous strain. Some "60 to 70% of the cost of raising a hog is tied up in the grains," Mr. Pope explains. "The major ingredient is corn, and the secondary ingredient is soybean meal." Over the last several years, "the cost of corn has gone from a base of $2.40 a bushel to today at $7.40 a bushel, nearly triple what it was just a few years ago." Which means every product that uses corn has risen, too—including everything from "cereal to soft drinks" and more.
Inflation: An overview of the prices consumers really pay .What triggered the upswing? In part: ethanol. President George W. Bush "came forward with—what do you call?—the edict that we were going to mandate 36 billion gallons of alternative fuels" by 2022, of which corn-based ethanol is "a substantial part." Companies that blend ethanol into fuel get a $5 billion annual tax credit, and there's a tariff to keep foreign producers out of the U.S. market. Now 40% of the corn crop is "directed to ethanol, which equals the amount that's going into livestock food," Mr. Pope calculates.
The rapidly depreciating dollar is also sparking inflation, although Mr. Pope says that's a "hard" topic for him to discuss, trying to be diplomatic. But he doesn't deny that money is cheap. Investment bankers are throwing cash at the firm—a turnaround from 2008, when money was scarce—even though Mr. Pope doesn't need it right now.
Now food price inflation is popping up across the country. A pound of sliced bacon costs $4.54 today versus $3.59 two years ago and $3.16 a decade ago, according to the Bureau of Labor Statistics. Ground beef is $2.72, up from $2.27 in 2009 and $1.74 in 2001. And it's not just Smithfield's products: "You eat eggs, you drink milk, you get a loaf of bread, and you get a pound of meat," he drawls. "Those are the four staples of what Americans eat in their diet. All of those are based on grains."
"Maybe to someone in the upper incomes it doesn't matter what the price of a pound of bacon is, or what the price of a ham, or the price of a pound of pork chops is," he says. "But for many of the customers we sell to, it really does matter." Workers can share cars when the price of oil rises, he quips, but "you can't share your food."
Mr. Pope also worries about the impact on farmers, who are leveraging up operations to afford the ever-rising price of land and fertilizer that has resulted from the increased corn demand. "There are record prices for livestock but farmers are exiting the business!" he exclaims. "Why? Farmers know they won't make money."
Weather is a factor, too. "We've had the luxury for the last three years of extremely good corn crops, with high yields and good growing conditions. We are just one bad weather event away from potentially $10 corn, which once again is another 50% increase in the input cost to our live production."
Food price inflation isn't a problem confined to America's shores. "This ethanol policy has impacted the world price of corn," Mr. Pope says. The Mexican, Canadian and European industries have "shrunk dramatically. . . . We have an unsustainable meat protein production industry," he says. "We're built on a platform of costs, on a policy that doesn't make any sense!"
Nor does the science. The ethanol industry would supply only 4% of the nation's annual energy needs even if it used 100% of the corn crop. The Environmental Protection Agency has found ethanol production has a neutral to negative impact on the environment. "The subsidy has been out there since the 1970s," Mr. Pope says. "If they can't make themselves into a viable economic model in 40 years, haven't we demonstrated that this is an industry that shouldn't exist?"
So what's the solution? First, Mr. Pope says, get rid of the ethanol subsidies and the tariff. "I am in competition with the government and the oil industry," he says. "It's not fair." Smithfield's economists estimate corn prices would fall by a dollar a bushel if ethanol blending wasn't subsidized. "Even the announcement that it is going away would see the price of corn go down, which would translate very quickly into reduced meat prices in the meat case," he says. Imagine what would happen if the mandate and tariff were eliminated, too.
He also advocates lifting regulatory and tax burdens on business. "I fundamentally don't understand the logic of corporate income taxes," he tells me. "If I have a 35% tax, all I do is take that 35% tax and I transfer it into the price of bacon and the price of pork chops."
Mr. Pope says the "losers" here "are the consumer, who's going to have to pay more for the product, and the livestock farmer who's going to have to buy high-priced grain that he can't afford because he's stretching his own lines of credit. The hog farmer . . . is in jeopardy of simply going out of business 'cause he doesn't have the cash liquidity to even pay for the corn to pay for the input to raise the hog. It's a dynamic that we can't sustain."
Coming on the heels of Bernanke's much-lauded first Fed press conference, Pope's remarks and Cochrane's editorial are quite sobering. Pope is quite explicit in painting the US ethanol policy as damaging to food prices with virtually no impact on oil importation, while ruinously effecting the price of corn as a global food supply mainstay. Then there's weather, which so few of us pay attention to for farming. Pope offers a rather cold-eyed assessment that we're almost certain to experience weather that could more than double current corn prices!
I wrote about that Bernanke's remarks,
"Yes, Bernanke did attempt to claim that commodity prices have surged due to developing nation demand, as Cramer predicted. Not that it was such a hard call to make.
The trouble is, it's not just oil. I don't think US food demand is down as much as its oil consumption is from a few years ago. But we have broad grocery store inflation approximating 10%.
Bernanke's hopes for moderated inflation while Americans pay more for food and gasoline just aren't believable. Further, technically, inflation is a monetary phenomenon, and Helicopter Ben has been monetizing Treasury debt and presiding over a weakening dollar."
So there you have it. A rather candid triangle of Bernanke spinning the Fed's ultra-cheap dollar policy as having absolutely nothing to do with imported inflation, Cochrane warning that even a whiff of inflation makes today's 30-year Treasury yields razor thin, and Larry Pope, a pragmatic pork processor CEO forseeing years of high food price inflation.
Who do you believe? The government employee, the financial academic and/or the CEO? No more than two can be right. If either Cochrane or Pope are right, Bernanke can't be.
Cochrane periodically pens editorials in the Journal, and they are always well-written and -reasoned. This one was no exception.
Early on, he associated current returns on a 30-year Treasury of 4.5% with a real 2% return, implying a long term inflation rate lower than 2.5%. With that rather risky bet as a background, he noted that such a belief of low inflation means,
"you have to bet they will solve the 2025 deficit. If you decide that the government will just keep kicking the deficit can down the road, sell your 30-year Treasuries. Sell fast, before everyone else does- because if we all try to sell, we just drive down the price and long-term interest rates rise."
Cochrane went on to chide the government for making the same mistake that Bear Stearns and Lehman did in 2008, i.e., fund excessively short-term for alleged reasons of lower cost, ignoring the risks of funding drying up when refinancing is undertaken. He warns,
"It is cheap precisely because it is dangerous."
So true, because the lender's view of short-term finance is that you aren't liable for the longer-term default. You only have to bet that the borrower, in this case the US, will manage to remain solvent for another few quarters or a year.
I won't go into Cochrane's comments on budget cuts, tax rates, etc., because they are more political in nature, and this is my business blog. However, he closes with these passages,
"The challenge is whether we will accept a vaguely rational tax system and a set of entitlements that protect the vulnerable without bankrupting the Treasury. It's not rocket science.
But we don't have much time. The bond market won't wait. The budget and debt problems will be much harder to solve if long-term interest rates spike, the dollar falls further, and inflation breaks out."
That last line caught my attention after I reread the piece following my reading of the weekend Journal's lead interview with Smithfield Foods CEO C. Larry Pope. Here are some of the passages from that piece,
"Mr. Pope is the chief executive officer of Smithfield Foods Inc., the world's largest pork processor and hog producer by volume. He doesn't mince words when it comes to rapidly rising food prices. The 56-year-old accountant by training has been in the business for more than three decades, and he warns that the higher costs may be here to stay.
It's also a business under enormous strain. Some "60 to 70% of the cost of raising a hog is tied up in the grains," Mr. Pope explains. "The major ingredient is corn, and the secondary ingredient is soybean meal." Over the last several years, "the cost of corn has gone from a base of $2.40 a bushel to today at $7.40 a bushel, nearly triple what it was just a few years ago." Which means every product that uses corn has risen, too—including everything from "cereal to soft drinks" and more.
Inflation: An overview of the prices consumers really pay .What triggered the upswing? In part: ethanol. President George W. Bush "came forward with—what do you call?—the edict that we were going to mandate 36 billion gallons of alternative fuels" by 2022, of which corn-based ethanol is "a substantial part." Companies that blend ethanol into fuel get a $5 billion annual tax credit, and there's a tariff to keep foreign producers out of the U.S. market. Now 40% of the corn crop is "directed to ethanol, which equals the amount that's going into livestock food," Mr. Pope calculates.
The rapidly depreciating dollar is also sparking inflation, although Mr. Pope says that's a "hard" topic for him to discuss, trying to be diplomatic. But he doesn't deny that money is cheap. Investment bankers are throwing cash at the firm—a turnaround from 2008, when money was scarce—even though Mr. Pope doesn't need it right now.
Now food price inflation is popping up across the country. A pound of sliced bacon costs $4.54 today versus $3.59 two years ago and $3.16 a decade ago, according to the Bureau of Labor Statistics. Ground beef is $2.72, up from $2.27 in 2009 and $1.74 in 2001. And it's not just Smithfield's products: "You eat eggs, you drink milk, you get a loaf of bread, and you get a pound of meat," he drawls. "Those are the four staples of what Americans eat in their diet. All of those are based on grains."
"Maybe to someone in the upper incomes it doesn't matter what the price of a pound of bacon is, or what the price of a ham, or the price of a pound of pork chops is," he says. "But for many of the customers we sell to, it really does matter." Workers can share cars when the price of oil rises, he quips, but "you can't share your food."
Mr. Pope also worries about the impact on farmers, who are leveraging up operations to afford the ever-rising price of land and fertilizer that has resulted from the increased corn demand. "There are record prices for livestock but farmers are exiting the business!" he exclaims. "Why? Farmers know they won't make money."
Weather is a factor, too. "We've had the luxury for the last three years of extremely good corn crops, with high yields and good growing conditions. We are just one bad weather event away from potentially $10 corn, which once again is another 50% increase in the input cost to our live production."
Food price inflation isn't a problem confined to America's shores. "This ethanol policy has impacted the world price of corn," Mr. Pope says. The Mexican, Canadian and European industries have "shrunk dramatically. . . . We have an unsustainable meat protein production industry," he says. "We're built on a platform of costs, on a policy that doesn't make any sense!"
Nor does the science. The ethanol industry would supply only 4% of the nation's annual energy needs even if it used 100% of the corn crop. The Environmental Protection Agency has found ethanol production has a neutral to negative impact on the environment. "The subsidy has been out there since the 1970s," Mr. Pope says. "If they can't make themselves into a viable economic model in 40 years, haven't we demonstrated that this is an industry that shouldn't exist?"
So what's the solution? First, Mr. Pope says, get rid of the ethanol subsidies and the tariff. "I am in competition with the government and the oil industry," he says. "It's not fair." Smithfield's economists estimate corn prices would fall by a dollar a bushel if ethanol blending wasn't subsidized. "Even the announcement that it is going away would see the price of corn go down, which would translate very quickly into reduced meat prices in the meat case," he says. Imagine what would happen if the mandate and tariff were eliminated, too.
He also advocates lifting regulatory and tax burdens on business. "I fundamentally don't understand the logic of corporate income taxes," he tells me. "If I have a 35% tax, all I do is take that 35% tax and I transfer it into the price of bacon and the price of pork chops."
Mr. Pope says the "losers" here "are the consumer, who's going to have to pay more for the product, and the livestock farmer who's going to have to buy high-priced grain that he can't afford because he's stretching his own lines of credit. The hog farmer . . . is in jeopardy of simply going out of business 'cause he doesn't have the cash liquidity to even pay for the corn to pay for the input to raise the hog. It's a dynamic that we can't sustain."
Coming on the heels of Bernanke's much-lauded first Fed press conference, Pope's remarks and Cochrane's editorial are quite sobering. Pope is quite explicit in painting the US ethanol policy as damaging to food prices with virtually no impact on oil importation, while ruinously effecting the price of corn as a global food supply mainstay. Then there's weather, which so few of us pay attention to for farming. Pope offers a rather cold-eyed assessment that we're almost certain to experience weather that could more than double current corn prices!
I wrote about that Bernanke's remarks,
"Yes, Bernanke did attempt to claim that commodity prices have surged due to developing nation demand, as Cramer predicted. Not that it was such a hard call to make.
The trouble is, it's not just oil. I don't think US food demand is down as much as its oil consumption is from a few years ago. But we have broad grocery store inflation approximating 10%.
Bernanke's hopes for moderated inflation while Americans pay more for food and gasoline just aren't believable. Further, technically, inflation is a monetary phenomenon, and Helicopter Ben has been monetizing Treasury debt and presiding over a weakening dollar."
So there you have it. A rather candid triangle of Bernanke spinning the Fed's ultra-cheap dollar policy as having absolutely nothing to do with imported inflation, Cochrane warning that even a whiff of inflation makes today's 30-year Treasury yields razor thin, and Larry Pope, a pragmatic pork processor CEO forseeing years of high food price inflation.
Who do you believe? The government employee, the financial academic and/or the CEO? No more than two can be right. If either Cochrane or Pope are right, Bernanke can't be.
Tuesday, April 19, 2011
Myopia From Dinallo & Geithner On CNBC This Morning
Sometimes you can understand why business people have such fear of government. This morning's incredibly myopic comments and narrow minded recollection of history by former New York Insurance Commissioner Eric Dinallo and Treasury Secretary Tim Geithner gave clear examples of grounds for this fear.
First Dinallo crowed about how effective his and Geithner's illegal taking of AIG by declaring it insolvent had been. It was truly scary to listen to Dinallo self-absorbed remarks, never allowing for the possibility, as several observers described at the time, that AIG's troubled financial products unit could have been separated from the solvent insurance operations, and separately taken through a Chapter 11 process, with all derivatives creditors taking proportional haircuts to resolve the unit's problems.
To hear Dinallo tell it, he crafted the best of all possible solutions, irrespective of the capricious nature of the seizing, or the general sense that, due to former NY AG Eliot Spitzer's animus toward AIG's former CEO, Hank Greenberg, the giant insurer was in for some truly 'special' treatment at the hands of New York and the feds.
Sadly, the co-anchors on the set let Dinallo spin his fairy tale of the soundness of the AIG seizure without a single probing question.
Then Tim Geithner appeared from Washington to easily hit some softball questions from the networks hapless senior economic reporter. Once again, the government official was allowed to go on and on without any interruptions for probing questions or serious challenges to his fairy tale.
In Geithner's case, the fairy tale is that yesterday's S&P warning on US debt is misplaced. That we haven't created too much debt which will be bequeathed to our children, and that extra spending on infrastructure and education is perfectly fine. Yes, the debt needs to be reduced, but certainly not at the cost of reining in special spending. Make sense? Not to me, either.
Both Dinallo's and Geithner's nearly robotic, surreal views that ignore reality ought to put fear into business people throughout the US. This is the attitude that causes investment to remain on the sidelines and hiring to be delayed. With government officials like these two inventing their own reality to justify power grabs and fiscal imprudence, there's no telling what overreach could come next from Washington or your own state capital.
At this point, in the interest of truth in packaging, CNBC should just relabel itself as a government public relations agency.
First Dinallo crowed about how effective his and Geithner's illegal taking of AIG by declaring it insolvent had been. It was truly scary to listen to Dinallo self-absorbed remarks, never allowing for the possibility, as several observers described at the time, that AIG's troubled financial products unit could have been separated from the solvent insurance operations, and separately taken through a Chapter 11 process, with all derivatives creditors taking proportional haircuts to resolve the unit's problems.
To hear Dinallo tell it, he crafted the best of all possible solutions, irrespective of the capricious nature of the seizing, or the general sense that, due to former NY AG Eliot Spitzer's animus toward AIG's former CEO, Hank Greenberg, the giant insurer was in for some truly 'special' treatment at the hands of New York and the feds.
Sadly, the co-anchors on the set let Dinallo spin his fairy tale of the soundness of the AIG seizure without a single probing question.
Then Tim Geithner appeared from Washington to easily hit some softball questions from the networks hapless senior economic reporter. Once again, the government official was allowed to go on and on without any interruptions for probing questions or serious challenges to his fairy tale.
In Geithner's case, the fairy tale is that yesterday's S&P warning on US debt is misplaced. That we haven't created too much debt which will be bequeathed to our children, and that extra spending on infrastructure and education is perfectly fine. Yes, the debt needs to be reduced, but certainly not at the cost of reining in special spending. Make sense? Not to me, either.
Both Dinallo's and Geithner's nearly robotic, surreal views that ignore reality ought to put fear into business people throughout the US. This is the attitude that causes investment to remain on the sidelines and hiring to be delayed. With government officials like these two inventing their own reality to justify power grabs and fiscal imprudence, there's no telling what overreach could come next from Washington or your own state capital.
At this point, in the interest of truth in packaging, CNBC should just relabel itself as a government public relations agency.
Thursday, April 14, 2011
Inflation, Commodity Prices & US Debt
Kelly Evans wrote on Tuesday, in her Wall Street Journal Ahead Of The Tape column, about M2's relatively slower growth in February. Her point was that, from Friedman's perspective ("inflation is always and everywhere a monetary phenomenon"), we aren't actually experiencing rampant inflation.
I've written in prior posts about the confusion between concepts such as that embodied in the misnamed CPI and monetarily-defined inflation. There's no question that the broadly-defined price indices are measuring a rise in the prices of commodities such as food and energy. But this isn't Friedman's view of 'inflation.'
But after reading Evans' column, I began to reflect on how Friedman would view the overall US monetary policy situation today.
The Fed's balance sheet is obscenely bloated. Some pundits are seriously discussing whether there would be a QE3 in light of the still-struggling US economy.
The Fed is monetizing US Treasury debt on a previously unheard of scale.
In this context, is it really sensible to limit the measure of monetary-based inflation to relatively-narrowly-defined concepts such as M2? What is velocity? Surely overall velocity of money and near-money is, on average, higher today, with increased use of electronic fund transfers, than it was in Friedman's prime. What has it been lately- rising, steady or falling?
With the Fed so queering the markets for money with its post-2008 easy money and excessive asset purchase policies, it seems silly to only look at the conventional monetary base growth and pronounce it tame.
Surely, amidst such huge amounts of net external US debt holdings and discussions of raising the debt limit, the notion of possible deflation seems contradictory.
Perhaps it's instructive to consider the past three years. With the US having been in a recession, while the Fed embarked on a program of propping up US financial institutions and the value of many of their assets, it's unlikely that monetary value growth during the period was slower than GDP growth.
While some prices remained fairly tame, due to recession-related lower demand, that seems to have ended, at least for agricultural and energy commodities. Meanwhile, GDP remains tepid.
So it's hard to believe that the net effect of the past several years has been US GDP growth that has outstripped that of US government money and credit creation. This situation does not seem to be changing now, or in the near future. Federal spending continues at levels which are increasing net external debt, while recent GDP growth was just scaled back the other day..
That would seem to me to qualify, from Friedman's perspective, as inflationary.
I've written in prior posts about the confusion between concepts such as that embodied in the misnamed CPI and monetarily-defined inflation. There's no question that the broadly-defined price indices are measuring a rise in the prices of commodities such as food and energy. But this isn't Friedman's view of 'inflation.'
But after reading Evans' column, I began to reflect on how Friedman would view the overall US monetary policy situation today.
The Fed's balance sheet is obscenely bloated. Some pundits are seriously discussing whether there would be a QE3 in light of the still-struggling US economy.
The Fed is monetizing US Treasury debt on a previously unheard of scale.
In this context, is it really sensible to limit the measure of monetary-based inflation to relatively-narrowly-defined concepts such as M2? What is velocity? Surely overall velocity of money and near-money is, on average, higher today, with increased use of electronic fund transfers, than it was in Friedman's prime. What has it been lately- rising, steady or falling?
With the Fed so queering the markets for money with its post-2008 easy money and excessive asset purchase policies, it seems silly to only look at the conventional monetary base growth and pronounce it tame.
Surely, amidst such huge amounts of net external US debt holdings and discussions of raising the debt limit, the notion of possible deflation seems contradictory.
Perhaps it's instructive to consider the past three years. With the US having been in a recession, while the Fed embarked on a program of propping up US financial institutions and the value of many of their assets, it's unlikely that monetary value growth during the period was slower than GDP growth.
While some prices remained fairly tame, due to recession-related lower demand, that seems to have ended, at least for agricultural and energy commodities. Meanwhile, GDP remains tepid.
So it's hard to believe that the net effect of the past several years has been US GDP growth that has outstripped that of US government money and credit creation. This situation does not seem to be changing now, or in the near future. Federal spending continues at levels which are increasing net external debt, while recent GDP growth was just scaled back the other day..
That would seem to me to qualify, from Friedman's perspective, as inflationary.
Monday, September 13, 2010
US Debt Levels & Interest Rates
Jason Trennert wrote an interesting little editorial in Friday's Wall Street Journal reminding us of the nature of short-term funding, and the folly of relying on it.
He ends his piece with a quote from Hemingway,
"In this context, it might be wise to remember Hemingway's Mike Campbell from "The Sun Also Rises," who, when asked how he went bankrupt, responded, "Gradually, then suddenly." "
Trennert is doing us all a service by reminding us of what happened to Bear Stearns and Lehman. When markets lose confidence, what was gradual bankruptcy, often in the form of higher interest rates and shorter lending maturities, suddenly becomes no funding at all.
He notes that the US Treasury has shortened our funding cycle to the point that we now owe "$5.2 trillion due in the next three years out of the $8.3 trillion outstanding."
That's more than 60% of our total outstanding debt, with much more being anticipated from increased deficits in the coming years.
Trennert also tells us that the current weighted-average funding cost is 1.21%- an absurdly low rate for the condition of the US government's financial situation. Much of that ultra-low rate is due, no doubt, to two factors. One, the massive holdings of US dollar-denominated debt by global investors, so that they can't easily just stampede out of dollars. And the lack of a viable, liquid alternative of sufficient capacity to absorb inflows if/when dollars are dumped.
Trennert notes, sagely,
"But the time to secure long-term funding is when you can and it is mildly expensive, not when you have to and the costs are exorbitant."
Or worse, you have to, and there is no cost at which you can extend your debt maturities.
To begin cutting our debt levels, the US will have to either save more, invest less. Both of these will slowly erode our GDP growth rates.
But continuing to rely on global investors to absorb ever more US debt with no end in sight is foolish.
Our current administration may, or may not, as Trennert points out, be using short-term funding to disguise the real costs of debt. But reliance on such short-term funding is ill-advised and too risky when betting on the ability to continue to place US debt while increasing its deficits.
But recent average 5-year note rates are 3.77%, roughly triple the current weighted-average, which would add $133 billion to the US government's annual interest rate bill.
He ends his piece with a quote from Hemingway,
"In this context, it might be wise to remember Hemingway's Mike Campbell from "The Sun Also Rises," who, when asked how he went bankrupt, responded, "Gradually, then suddenly." "
Trennert is doing us all a service by reminding us of what happened to Bear Stearns and Lehman. When markets lose confidence, what was gradual bankruptcy, often in the form of higher interest rates and shorter lending maturities, suddenly becomes no funding at all.
He notes that the US Treasury has shortened our funding cycle to the point that we now owe "$5.2 trillion due in the next three years out of the $8.3 trillion outstanding."
That's more than 60% of our total outstanding debt, with much more being anticipated from increased deficits in the coming years.
Trennert also tells us that the current weighted-average funding cost is 1.21%- an absurdly low rate for the condition of the US government's financial situation. Much of that ultra-low rate is due, no doubt, to two factors. One, the massive holdings of US dollar-denominated debt by global investors, so that they can't easily just stampede out of dollars. And the lack of a viable, liquid alternative of sufficient capacity to absorb inflows if/when dollars are dumped.
Trennert notes, sagely,
"But the time to secure long-term funding is when you can and it is mildly expensive, not when you have to and the costs are exorbitant."
Or worse, you have to, and there is no cost at which you can extend your debt maturities.
To begin cutting our debt levels, the US will have to either save more, invest less. Both of these will slowly erode our GDP growth rates.
But continuing to rely on global investors to absorb ever more US debt with no end in sight is foolish.
Our current administration may, or may not, as Trennert points out, be using short-term funding to disguise the real costs of debt. But reliance on such short-term funding is ill-advised and too risky when betting on the ability to continue to place US debt while increasing its deficits.
But recent average 5-year note rates are 3.77%, roughly triple the current weighted-average, which would add $133 billion to the US government's annual interest rate bill.
Monday, November 30, 2009
The Next "Tipping Point"
Back in January of this year, I wrote this post concerning the issues of capital creation and private versus public money used as leverage in the economy. I referred to it recently when I wrote this post about Doug Dachille's recent confirmation of my observations.
The question of how excessive leverage enters an economic system was of interest to me. It seems to be something that everyone takes for granted, but few probably can explain.
After tracing the evolution of economics from barter to modern global finance using a multiplicity of fiat currencies, I wrote,
"Somehow, through the centuries, capital creation became increasingly dependent not upon hard assets or saved money, but some analyst's or banker's estimation of the forward earnings power of an entity issuing debt or offering equity subscriptions.
Culminating in events including the famed technology equity 'bubble' of the late 1990s and the recent real estate bubble of the late 2000s, the financial community's allowance of increased leverage, via lending on ever-smaller equity bases, resulted in economic expansion which has to have been secularly due to that higher leverage."
It's no secret that a government's printing of money or issuing of debt creates money which can be used as capital. If that monetary base creation isn't related to some sort of tangible value, then that is a source of excess leverage. In effect, a government's creation of money out of nothing has the same effect as bringing forward years, perhaps decades of value not yet created, and putting it into circulation as if it were already in existence.
There is a secondary manner in which newly-created or existing money can be the basis for excessive capital creation. That would be a market demand for some asset, usually equities or "hard" assets, which simply spirals upwards as a function of bidding on the assets.
A capital-creating phenomenon which occurs here which is so insidious because of the nature of open markets. When you or I bid up the price of the marginal share of a company's equity, we only have to pay for the accepted, higher value of those few shares. But everyone owning those shares feels wealthier by the amount per share which we have bid up the price.
If, in that instant, all those other shareholders borrowed against the new, higher value, then capital is magically created, less the 50% margin withheld by brokers, in an amount directly related to the price rise from just our trade for a fraction of the company's equity.
My point is, markets for privately-held assets can, by generally positive sentiment, cause rises in apparent value which can also serve as bases for capital base expansion.
Thus, we have to take as a given that, at times, the global sum of capital available may vastly exceed the actual, tangible savings.
From such events are financial bubbles born. Today, we have the Dubai World debt problem. A decade ago, the US technology equity bubble was about to burst. After September, 2001, Fed chairman Alan Greenspan touched off a decade-long real estate finance bubble by holding benchmark US interest rates too low for far too long, effectively creating too much capital in advance of its actual, tangible realization.
As I discussed these topics with a business colleagues yesterday morning, I was struck by how, somewhere in the past forty years, from about the time of Reagan's election to the Presidency, we moved from a largely prudent capital creation environment to one which could be more aptly described as 'borrow it forward.'
In a bi-partisan manner, US presidential administrations and the Congress joined the party, running continual deficits. The so-called "peace dividend" of the Clinton years was spent. Congress went further, simply borrowing from the world via Treasury-issued debt, rather than ever even attempt to balance the total federal budget, both on- and off-balance sheet, including Medicare and Social Security.
Since FDR began his first term in 1932, the US lost a sense of fiscal rectitude, and became comfortable with, then addicted to, running deficits, both in wartime and peacetime. It seems to me that this unbridled borrowing binge by the US for the past 80 years is about to come to an end.
Until perhaps 20 years ago, when no other major country had substantial economic power, and the dollar was the undisputed reserve currency in a world which included the hostile, communist Soviet Union and China, such deficits were disguised as Western world capital seeking safety in the greenback.
Now, with other major countries having evolved economically to the point of having substantial trade surpluses, and a lack of such imminent danger from communistic countries, other asset classes are seen as viable, and the excess dollars now have resulted in deprecation of the currency.
It seems to me that, with this background, the US is very near to an economic "tipping point."
Most uses of the phrase these days are political. They refer to the point at which poor voters in the US will use their numbers to vote in lush, perpetual welfare-state programs, overwhelming the votes of productive, working taxpayers.
However, I believe that this latter phenomenon won't actually occur, because the former, economic tipping point, will be reached first. And that will preclude the latter one.
How? Why?
Somewhere in the midst of my colleague's and my discussion on Sunday morning, I remembered a little vignette from a television program I happened to see for about 5 minutes while channel surfing on Saturday.
One of those "Real Housewives of" programs happened to be on, and I saw a recap of a prior episode, and the trailer for the one about to air. What I recall was this Orange County couple sitting with a realtor and agreeing to list their OC McMansion for something like $1.4MM. The husband bemoaned having "seen this coming" two years earlier, when the market-fueled mania priced the same home at around $2.1MM. The wife sobbed as they confessed that the proposed sale price would put them underwater when paying off the mortgage on the home in question.
For some reason, my first reaction was to recall the apocryphal story from 1929 involving JP Morgan and his shoeshine man. The story goes that when Morgan- or perhaps a Vanderbilt or some other wealthy financial luminary- heard his lowly shoeshiner presuming to give him stock tips, the market was dangerously overbought. According to the tale, the financier went to his office and immediately sold all of his equities, putting the proceeds into cash.
The Orange County McMansion tale calls that apocryphal tale to mind, I suppose, because it suggests that excessive leverage has become so woven into the fabric of the US society that some who appear to be wealthy have, in fact, been living on 'borrowed forward' money after all.
From unfunded federal Social Security promises to proposed, bloated health care bills, to essentially bankrupt states such as California, Michigan and, soon, Illinois and New Jersey, our government has become a profligate spender of other people's money in a manner that just got Bernard Madoff a life sentence in prison.
The only times in recent memory that the US dollar has risen in value relative to other currencies has been when global economic doom seemed imminent. If that's what it takes to save the dollar, I doubt those will be economic conditions conducive to the US enjoying healthy growth in the private sector.
No, I suspect that, though the exact timing is unknown, the US dollar and the debt obligations of its government will soon experience significant shunning. I discussed some of the implications of Lawrence Kadish's recent Wall Street Journal editorial on the size of the current interest expense of the federal government in this post, writing,
"You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.
Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.
And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries."
For the record, the current administration's budget assumes an interest rate on US debt of half of the average of the past decade! That's simply not credible.
This is all simply unsustainable. Too much imaginary capital has been borrowed forward from decades in the future, and much of it has been invested in depreciating dollars or Treasuries denominated in the same depreciating currency.
My partner and I manage proprietary equity options investments, so we must be sensitive to actual, ongoing timing issues between calls and puts. It's not sufficient, for investment management purposes, to see a massive credit crunch returning sometime in the next two or three years.
But I do think that will happen. I don't think the Democrats in Congress and the administration will successfully remain in power for more than three more years if even one of the proposed deficit-increasing, budget-busting bills is passed into law. It is simply not believable that savers around the globe will willingly hand over their tangible, hard-earned capital to the US in order to see it spent on environmentally-popular programs in a currency that will continue to lose value.
The question of how excessive leverage enters an economic system was of interest to me. It seems to be something that everyone takes for granted, but few probably can explain.
After tracing the evolution of economics from barter to modern global finance using a multiplicity of fiat currencies, I wrote,
"Somehow, through the centuries, capital creation became increasingly dependent not upon hard assets or saved money, but some analyst's or banker's estimation of the forward earnings power of an entity issuing debt or offering equity subscriptions.
Culminating in events including the famed technology equity 'bubble' of the late 1990s and the recent real estate bubble of the late 2000s, the financial community's allowance of increased leverage, via lending on ever-smaller equity bases, resulted in economic expansion which has to have been secularly due to that higher leverage."
It's no secret that a government's printing of money or issuing of debt creates money which can be used as capital. If that monetary base creation isn't related to some sort of tangible value, then that is a source of excess leverage. In effect, a government's creation of money out of nothing has the same effect as bringing forward years, perhaps decades of value not yet created, and putting it into circulation as if it were already in existence.
There is a secondary manner in which newly-created or existing money can be the basis for excessive capital creation. That would be a market demand for some asset, usually equities or "hard" assets, which simply spirals upwards as a function of bidding on the assets.
A capital-creating phenomenon which occurs here which is so insidious because of the nature of open markets. When you or I bid up the price of the marginal share of a company's equity, we only have to pay for the accepted, higher value of those few shares. But everyone owning those shares feels wealthier by the amount per share which we have bid up the price.
If, in that instant, all those other shareholders borrowed against the new, higher value, then capital is magically created, less the 50% margin withheld by brokers, in an amount directly related to the price rise from just our trade for a fraction of the company's equity.
My point is, markets for privately-held assets can, by generally positive sentiment, cause rises in apparent value which can also serve as bases for capital base expansion.
Thus, we have to take as a given that, at times, the global sum of capital available may vastly exceed the actual, tangible savings.
From such events are financial bubbles born. Today, we have the Dubai World debt problem. A decade ago, the US technology equity bubble was about to burst. After September, 2001, Fed chairman Alan Greenspan touched off a decade-long real estate finance bubble by holding benchmark US interest rates too low for far too long, effectively creating too much capital in advance of its actual, tangible realization.
As I discussed these topics with a business colleagues yesterday morning, I was struck by how, somewhere in the past forty years, from about the time of Reagan's election to the Presidency, we moved from a largely prudent capital creation environment to one which could be more aptly described as 'borrow it forward.'
In a bi-partisan manner, US presidential administrations and the Congress joined the party, running continual deficits. The so-called "peace dividend" of the Clinton years was spent. Congress went further, simply borrowing from the world via Treasury-issued debt, rather than ever even attempt to balance the total federal budget, both on- and off-balance sheet, including Medicare and Social Security.
Since FDR began his first term in 1932, the US lost a sense of fiscal rectitude, and became comfortable with, then addicted to, running deficits, both in wartime and peacetime. It seems to me that this unbridled borrowing binge by the US for the past 80 years is about to come to an end.
Until perhaps 20 years ago, when no other major country had substantial economic power, and the dollar was the undisputed reserve currency in a world which included the hostile, communist Soviet Union and China, such deficits were disguised as Western world capital seeking safety in the greenback.
Now, with other major countries having evolved economically to the point of having substantial trade surpluses, and a lack of such imminent danger from communistic countries, other asset classes are seen as viable, and the excess dollars now have resulted in deprecation of the currency.
It seems to me that, with this background, the US is very near to an economic "tipping point."
Most uses of the phrase these days are political. They refer to the point at which poor voters in the US will use their numbers to vote in lush, perpetual welfare-state programs, overwhelming the votes of productive, working taxpayers.
However, I believe that this latter phenomenon won't actually occur, because the former, economic tipping point, will be reached first. And that will preclude the latter one.
How? Why?
Somewhere in the midst of my colleague's and my discussion on Sunday morning, I remembered a little vignette from a television program I happened to see for about 5 minutes while channel surfing on Saturday.
One of those "Real Housewives of" programs happened to be on, and I saw a recap of a prior episode, and the trailer for the one about to air. What I recall was this Orange County couple sitting with a realtor and agreeing to list their OC McMansion for something like $1.4MM. The husband bemoaned having "seen this coming" two years earlier, when the market-fueled mania priced the same home at around $2.1MM. The wife sobbed as they confessed that the proposed sale price would put them underwater when paying off the mortgage on the home in question.
For some reason, my first reaction was to recall the apocryphal story from 1929 involving JP Morgan and his shoeshine man. The story goes that when Morgan- or perhaps a Vanderbilt or some other wealthy financial luminary- heard his lowly shoeshiner presuming to give him stock tips, the market was dangerously overbought. According to the tale, the financier went to his office and immediately sold all of his equities, putting the proceeds into cash.
The Orange County McMansion tale calls that apocryphal tale to mind, I suppose, because it suggests that excessive leverage has become so woven into the fabric of the US society that some who appear to be wealthy have, in fact, been living on 'borrowed forward' money after all.
From unfunded federal Social Security promises to proposed, bloated health care bills, to essentially bankrupt states such as California, Michigan and, soon, Illinois and New Jersey, our government has become a profligate spender of other people's money in a manner that just got Bernard Madoff a life sentence in prison.
The only times in recent memory that the US dollar has risen in value relative to other currencies has been when global economic doom seemed imminent. If that's what it takes to save the dollar, I doubt those will be economic conditions conducive to the US enjoying healthy growth in the private sector.
No, I suspect that, though the exact timing is unknown, the US dollar and the debt obligations of its government will soon experience significant shunning. I discussed some of the implications of Lawrence Kadish's recent Wall Street Journal editorial on the size of the current interest expense of the federal government in this post, writing,
"You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.
Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.
And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries."
For the record, the current administration's budget assumes an interest rate on US debt of half of the average of the past decade! That's simply not credible.
This is all simply unsustainable. Too much imaginary capital has been borrowed forward from decades in the future, and much of it has been invested in depreciating dollars or Treasuries denominated in the same depreciating currency.
My partner and I manage proprietary equity options investments, so we must be sensitive to actual, ongoing timing issues between calls and puts. It's not sufficient, for investment management purposes, to see a massive credit crunch returning sometime in the next two or three years.
But I do think that will happen. I don't think the Democrats in Congress and the administration will successfully remain in power for more than three more years if even one of the proposed deficit-increasing, budget-busting bills is passed into law. It is simply not believable that savers around the globe will willingly hand over their tangible, hard-earned capital to the US in order to see it spent on environmentally-popular programs in a currency that will continue to lose value.
Tuesday, October 13, 2009
Interest Expense of the US National Debt
I read a piece in the Wall Street Journal yesterday by Lawrence Kadish that left me stunned.
Kadish uses CBO and Bureau of the Public Debt figures to sketch out a horrifying scenario.
At the end of last month, the US national indebtedness stood at nearly $12 trillion. Interest expense for this year on that amount will be $383B.
Kadish then uses CBO figures to derive this year's estimated personal income tax payments as around $904B. Dividing the interest expense for this year into personal income taxes, he derives the shocking rate of more roughly 40%.
True, one could use the estimated $2 trillion government receipts for 2009 instead, making the figure a more palatable 19%. But, in reality, taxes are always and ultimately borne by people. Institutions merely collect taxes indirectly for governments.
Kadish goes on to note that the US government has run deficits constantly, except for those few years of the elusive "peace dividend" following the USSR's breakup, for decades. So, predicting to the mean, or prior behavior, it probably will try to do so going forward, as well.
Now, due in part to the recent financial meltdown and global flooding of liquidity by central banks, interest rates on Treasuries are currently around 3%. But in the Carter years, it was as high as 15%.
Now add in OMB's projections of deficits amounting to some $9 trillion over the next decade, meaning a near-doubling.
You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.
Will US per capita income rise by five-fold in a decade? Unlikely. Unless you mean purely through inflation. Real incomes certainly will not. If the US economy grew at a steady 3.5% each year and it was all due to productivity, meaning the entire gain went to increase personal incomes, they would only grow by about 40%.
Kadish goes on to state,
"Eventually, most of what we spend on Social Security, Medicare, education national defense and much more may have to come from new borrowing, if such funding can be obtained."
The options, Kadish writes, will become default or hyperinflation.
In prior decades, when our debt was widely held by western powers and investors, our appetite for social programs hadn't reached its current level. Longer ago, the US dollar was a prized, stable store of value in the post-WWII era.
Now, the world's major growth economies are no longer friends, e.g., China, Brazil, India. They won't necessarily even do us the favor of lending in dollars. If so, it will be at exorbitant rates.
Kadish's final point is to cite Steve Forbes as saying that the national debt is one issue which will motivate US voters to take action on Washington's profligacy.
I believe that. But on the way there, it's going to get very scary.
Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.
And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries.
Perhaps this is why I'm finding less to write about in the corporate world these days than in the world of Washington-centric business and financial dealings.
Kadish uses CBO and Bureau of the Public Debt figures to sketch out a horrifying scenario.
At the end of last month, the US national indebtedness stood at nearly $12 trillion. Interest expense for this year on that amount will be $383B.
Kadish then uses CBO figures to derive this year's estimated personal income tax payments as around $904B. Dividing the interest expense for this year into personal income taxes, he derives the shocking rate of more roughly 40%.
True, one could use the estimated $2 trillion government receipts for 2009 instead, making the figure a more palatable 19%. But, in reality, taxes are always and ultimately borne by people. Institutions merely collect taxes indirectly for governments.
Kadish goes on to note that the US government has run deficits constantly, except for those few years of the elusive "peace dividend" following the USSR's breakup, for decades. So, predicting to the mean, or prior behavior, it probably will try to do so going forward, as well.
Now, due in part to the recent financial meltdown and global flooding of liquidity by central banks, interest rates on Treasuries are currently around 3%. But in the Carter years, it was as high as 15%.
Now add in OMB's projections of deficits amounting to some $9 trillion over the next decade, meaning a near-doubling.
You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.
Will US per capita income rise by five-fold in a decade? Unlikely. Unless you mean purely through inflation. Real incomes certainly will not. If the US economy grew at a steady 3.5% each year and it was all due to productivity, meaning the entire gain went to increase personal incomes, they would only grow by about 40%.
Kadish goes on to state,
"Eventually, most of what we spend on Social Security, Medicare, education national defense and much more may have to come from new borrowing, if such funding can be obtained."
The options, Kadish writes, will become default or hyperinflation.
In prior decades, when our debt was widely held by western powers and investors, our appetite for social programs hadn't reached its current level. Longer ago, the US dollar was a prized, stable store of value in the post-WWII era.
Now, the world's major growth economies are no longer friends, e.g., China, Brazil, India. They won't necessarily even do us the favor of lending in dollars. If so, it will be at exorbitant rates.
Kadish's final point is to cite Steve Forbes as saying that the national debt is one issue which will motivate US voters to take action on Washington's profligacy.
I believe that. But on the way there, it's going to get very scary.
Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.
And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries.
Perhaps this is why I'm finding less to write about in the corporate world these days than in the world of Washington-centric business and financial dealings.
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