Market Ticker often posts this graph of total debt (public and private) in the US:
We can see from that graph that the trend is now changed to “down” after 50 years of “up”. The Federal government has been unsuccessfully attempting to offset the decline in private debt with increases in public debt. With the trend to more austere budgets, the growth rate in Federal debt will also begin to decline, accelerating the decline in total debt. What does this mean for interest rates? A shrinking supply of total debt means there is a shrinking supply of debt securities in which investors can invest. All other things held constant, this implies that debt prices will be bid up and interest rates down. In the case of US Treasury debt, we can expect a significant fraction of it to be monetized – bought by the Federal Reserve and paid for with Dollars that don’t cost the Treasury any interest. This monetization process will not increase the total amount of dollars available, but it will further reduce the supply of interest bearing debt instruments available for investors to buy – resulting in still more upward pressure on Treasury prices and downward pressure on rates. There appears substantial probability that long term Treasury Bond rates could be cut in half (from 4 to 2%) within 18 months. Only when the private economy begins to recover with real, non-government financed growth will we have significant risk of a rise in interest rates.
Bloomberg reports that the evil “bond market vigilantes” are trying to prevent the government from doing what it thinks it needs to do to revive the economy:
For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.
“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. “Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”
“The vigilante group is different this time around,” said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. “It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.”
Swamp Report congratulates bond market participants for just saying no and suggests those “vigilantes” keep up the good work even if they are the new axis of evil…
From Market Watch:
1.The jobs picture darkens
2. Energy prices continue to vault higher
3. Interest rates start to escalate
4. Contrarian indicators like the VIX reach new extremes
5. Corporate earnings results disappoint
Only 1 or 2 of the above could wind up being the market’s “justification” for taking the prices lower.
In a previous post we highlighted the fact that with payroll taxes substantially reduced, the social security administration will very soon have to begin selling some of it $2+ trillion holdings of US debt to meet social security benefit obligations. The 2008 annual report of the Social Security Trustees says:
“The drawdown of Social Security and HI Trust Fund reserves and the general revenue transfers into SMI will result in mounting pressure on the Federal budget. In fact, pressure is already evident.
We are increasingly concerned about inaction on the financial challenges facing the Social Security and Medicare programs. The longer action is delayed, the greater will be the required adjustments, the larger the burden on future generations, and the more severe the detrimental economic impact on our nation.
The annual cost of Social Security benefits represented 4.3 percent of Gross Domestic Product (GDP) in 2007 and is projected to increase to 6.1 percent of GDP in 2035, and then decline to 5.8 percent of GDP by 2048 and remain at that level.”
This report does not have the CBO’s recently adjusted numbers taken into account. A little math: Assuming 4.3% of a 14 trillion GDP level implies that social security benefit obligations are around $600B per year. If (say) half that many treasuries ($300B) are sold to meet the obligations next year, that’s a potential problem as big as the possibility the one that China might reduce its purchases of US debt.
ml-implode.com reports that according to the CBO, social security will run out money much sooner than projected even last year due to reduced payroll tax receipts:
“Last year, the CBO figured the surplus would be $80 billion this year and next, rising from those levels before falling to zero in about ten years. The most recent projections are for a slim $16 billion surplus this year and just $3 billion next year but, given the rosy predictions that usually come out of Washington, a deficit is certainly within the realm of possibilities.
This is bad. We were supposed to have until 2012 that Social Security would still be in a “surplus” — meaning more SS taxes were being taken in than outlays. Thus, Social Security would be contributing to the government’s general operating revenue until that time (the Social Security money taken in is not segregated in any way — it is just “tracked” through the holding of Treasury Securities).
Apparently, that “lucky” state of affairs is all but over — now the fund will have to start selling off its trillion or so of accumulated Treasuries, contributing to the overall funding problem of the Federal Government, at the worst possible time.
The US is bankrupt, folks. Its time to acknowledge it and deal with it.”