3/11/2014

Sooner Or Later the Repo Man Will Show Up

I've heard talking heads on TV say numerous times regarding the national debt, that Federal debt is not the same as State government debt or personal debt.  Federal debt is not a problem.  What world do they live in?

Federal debt is public debt.  That means they are borrowing and using me and you, and our lives as collateral; it affects our lives and we have nothing to say about except through our votes, and most of us are too stupid or too lazy to manage our own finances much less vote responsibly.

Bottom line?  We're screwed, and we will all pay in a very big way.

Tomorrow's Problem: Paying Interest On US Debt

Intelligent investors don't just look at today's macro environment, they look ahead to tomorrow.
In the short term (think the next few years), the Congressional Budget Office (CBO) has projected the U.S. federal budget deficit will shrink. But, looking toward the end of the decade, U.S. deficits are expected to rise again. The key factors are widely known and in part revolve around the aging population in the U.S., rising health care costs, an increase to federal subsidies for health insurance and perhaps most importantly growing interest payments on federal debt.
Borrowing to pay the interest —that is not a good situation for anyone's balance sheet whether you are a consumer or a government. And, the U.S. government has had the luxury of ultra-low interest rates (thanks to the Federal Reserve since 2008 as the central bank attempted to keep liquidity flowing through the credit frozen and stalled financial system) in recent years, but that is changing now.
Interest rates are already on the rise. As the U.S. Federal Reserve continues to push toward monetary policy normalization, which generally puts the federal funds rate around 4.0%, longer term interest rates are expected to continue to rise as well.
Looking back at action last year, the trend toward higher rates has already started. In 2013, the benchmark 10-year note Treasury yield already saw a fairly sizeable increase from 1.69% in late December 2012, to an intraday high at 3.036% in early January 2014.
Think back to before the global financial crisis. Where were 10-year yields then?
  • In June 2007, the 10-year yield stood at 5.31%.
  • In January 2000, the 10-year yield stood at 6.82%.
  • In July 1996, 10-year yields registered a 7.09% reading
  • In November 1994 a high was seen at 8.16%. 
It is so easy to forget that interest rates used to be much higher, substantially higher.
For now, the Fed is tapering its monthly bond purchases and a move toward policy normalization is set into the GPS system. The Fed will be driving the financial system toward higher rates in the months and years ahead.
Let's look at what that could mean for payments on the deficit. First, where could the deficit be in a decade? "If current laws do not change, the CBO puts the deficit up to 4% of GDP in ten years. And the overall debt in the hands of the public, under the same current law assumptions, will equal 79% of GDP in 2024 and be on an upward path," according to Credit Suisse economists.
Simply put, higher market interest rates translate into higher interest payments on outstanding debt payments.
"If the CBO interest rate assumptions came to pass, net interest payments would equal 82% of a projected $1.1 trillion budget deficit in 2024," said Credit Suisse analysts.
"When interest rates rise, debt service expense goes up on all the outstanding debt (the pace depending on the term structure), not just on the incremental debt represented by the deficit.  The increased expense on existing debt is forced upward as it matures and is rolled over on less generous terms," said Credit Suisse.
"That means pledging the tax revenues of the government or diverting them from programmatic goals to pay interest. If the CBO projections came to pass, net  interest  would equal 18 % of tax revenues, 17% of all other federal outlays, and a whopping 82% of the budget deficit ten years from now," according to Credit Suisse.
In plain English? Higher rates mean a larger portion of the government's outlays need to go toward debt repayment and less toward the military, roads, education, and whatever other services the government spends money on.
Could this all become a vicious circle? While the Fed is trying to normalize rates, Credit Suisse warns debt dynamics could force the Fed to shift gears and easy monetary policy again.
"If market interest rates began to put the fiscal position at risk of explosive debt dynamics, economic activity might be weakening noticeably, as would the central bank’s forecast. It could then step in with interest rate cuts or  a new round large-scale asset purchases to offset market pressures. In this scenario, once the Fed begins tightening monetary policy and hiking interest rates, it is unlikely to get very far before it needs to pause or turn around and ease again," Credit Suisse concluded.
Gold investors plan for both today and tomorrow. And, there remain some rocky waters ahead.
Kira Brecht is managing editor at TraderPlanet.

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