By Chris Hamilton
“Fat, drunk, and stupid is no way to go through life*…” and never has this been more apropos than now. Americans may have occasionally tied one too many on and certainly have enjoyed more than their share of McFatty meals. Less visible but possibly of greater importance is the toxic combined lack of educational push and/or individual pull to understand the finances and economics in which we live, work, and perhaps hope to raise a family. American’s are simply economically irresponsible and clueless.
(*Dean Wormer in the film, Animal House)
But I (foolishly) believe each of us have a role to make this nation function and it’s not simple minded consumerism. The first step in a culture or society is the shared understanding of how and why we became who we are and then a basic understanding of how we maintain this. Without this commitment to knowledge we are ignorant and vulnerable. Many inaccurately assume the high priest economists, politicians, etc. of our modern day society are looking out for our best interests so no need to bother. This economic illiteracy leaves Americans gullible of the worst sort of lies and ultimately leaves the majority incapable of warding off abuses of the few for the few.
I don’t know if it’s been a breakdown of civics education, a lack of interest in increasingly complex finance and economics, or if these things were once upon a time ignored as the small affairs of a far off place only marginally impacting a primarily agrarian society…but I’m certain the vast, vast majority of American’s have only a notion of what is actually happening and lack an internal compass to alert them to the half-truths, cons, and fraud offered by so many of our governmental, industrial, and financial leaders. Knowledge detailing the size and relationships of the economy, taxes, growth, and debt can be memorized in short order…less time than watching a single NBA or NFL game. This alone won’t fix the problems we face but with knowledge comes the shared recognition of problems and then hopefully an honest dialogue leading to a compulsion to act.
Our time on this earth is measured by our actions and although I can’t promise this knowledge can fix what ails us, I can promise that making the effort and taking action to spread literacy and knowledge is our best hope.
THE ECONOMIC LANDSCAPE
The US has roughly $100 trillion in assets and an economy (all economic movement of goods and services in the US in a calendar year) of $16.8 trillion. Federal tax revenue of $2.8 trillion vs. Federal spending of $3.5 trillion – creating a 2013 budget deficit of $680 billion. This deficit spending was a 4.4% boost to the US economy in ’13 and is factored into the 1.5% “economic growth” of GDP…otherwise put, absent the deficit spending, the US economy contracted last year and has been contracting every year since ’08! It should be no surprise then that as budget deficits are shrinking, GDP shrinks in kind.
- US Total Market Value = $100 Trillion
- $40 Trillion Bonds
- $35 Trillion Real Estate ($27 Trillion Residential / $8 Trillion Commercial)
- $25 Trillion Stocks
- BTW – $100 to $200 Trillion US unfunded liabilities (net present value)…this is a discussion for another day.
- $16.8 Trillion US economy, 2013 (gross domestic product)
- $2.8 Trillion Federal tax revenue (taxes in)
- $3.5 Trillion Federal budget (spending out)
- -$680 Billion budget deficit (bridged by sale of Treasury debt spent now and counted as a portion of GDP)
- = $550 Billion economic growth?!? (If that doesn’t look a little funny, look again).
FYR – Reminder; Million —> Billion (1,000 million) —> Trillion (1,000 billion)
In short, Congress designates money to be spent but does not provide the means to collect it, the Treasury issues the debt to be spent now and paid back “later”, and the Federal Reserve creates dollars to buy (monetize) Treasury and mortgage debt in a program called Quantitative Easing (QE) to help maintain low interest rates. However, the government never intends to pay back what is borrowed and instead only hopes to service the ever mounting debt at ever lower rates and with printed money, if necessary. The Treasury has created real supply of debt but the Federal Reserve have created false demand to drive rates down. But the supply side debt does not taper although the Fed has proposed to taper their demand side QE.
In a capitalistic model, people borrow expecting that the loan will provide enough financing to generate revenues greater than expenses; which will allow for future repayment of the loan and a profit for the borrower. However, in a centralized model, debt is created to paper over any shortfall between taxes paid and the spending desires of the government. Repayment of the loan or even the impact of future higher interest rates is of zero concern to the current government given term limits, etc.
US TREASURY = ULTIMATE ENABLER (shocker!)
At the core of it all is the US Treasury (acting in conjunction with the Congress and Federal Reserve) as the “ultimate enabler” allowing for US government spending well beyond our tax receipts. And the Treasury has issued Bills, Notes, Bonds and various other debt vehicles to the tune of $17.5 trillion. The $17.5 trillion debt will only go up. No payment to the principal has been made for over 40 years and instead America has chosen to make the minimum “interest-only” payments. Paying any more than the present $221 billion annually in interest would take funds away from other government programs or simply result in even larger annual deficits. So the Treasury debt continues growing…and far faster than the economy which is taxed to pay for the interest.
- ’00 —————> ’07 ———–> Mar ’14
- $9.2 Trillion —–> $13.7 T ——-> $16.8 T (US Gross Domestic Product (GDP) = 80% increase)
- $5.7 Trillion —–> $9 T ——-> $17.5 T (National debt = 305% increase )
But the shocker is that although the Federal government debt has nearly tripled since ’00 the interest rates have fallen nearly 2/3rds and total interest payments for this debt have fallen by nearly 1/3rd.
- 6.6% ————–> 5% ——–> 2.4% (net interest rate on debt)
- $300 Billion —–> $270 B ——-> $221B (net interest paid on national debt)
What could be greater? The more debt we take on to spend now and pay back later, the less it costs.
There are only three possible sources of Treasury buyers; Foreigners, Federal Reserve, and Domestic entities. The Federal Reserve have sold all Bills (less than 1 year duration debt instruments) to focus all purchasing on longer duration notes and bonds. Foreigners have maintained their % of holdings but significantly increased the total dollar value of Treasury’s held. The Fed and Foreigners collectively now hold 70% of Public Treasury Notes and Bonds (1 to 30 year durations). BTW – Mortgage rates based on the 10yr Treasury have been forced down to record lows thanks to this robust “demand”.
FOREIGN HOLDINGS- Typically purchased within nations running a trade surplus with the US and looking to recycle excess dollars into a yielding asset or those in need of “riskless” assets.
- ’00 ——————-> ’07 ———–> Mar ’14
- $1.25 Trillion——> $2.38T ———> $5.95 T (cumulative “Foreign”** held US Treasury debt)
- 40% ————–> 53% ———> 49% (% of total outstanding public notes / bonds held by “foreigners”)
** “The data are collected primarily from U.S.-based custodians. Since U.S. securities held in overseas custody accounts may not be attributed to the actual owners, the data may not provide a precise accounting of individual country ownership of Treasury securities (see TIC FAQ #7 at: http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticfaq1.aspx).
FEDERAL RESERVE HOLDINGS
- $502 Billion ——> $741 B ——–> $2.3 Trillion (cumulative Fed holdings)
- 12% —————> 13% ———-> 21% (% of total outstanding public notes / bonds held by Fed)
DOMESTIC HOLDINGS- Domestic sources of buying are those in need of fixed income and/or high quality assets (pensions, insurers, households, mutual funds, and state / local governments).
- $1.7 Trillion——-> $1.8 T ——-> $4.1 T (cumulative Domestic holdings)
- 48% —————-> 34% ——–> 30% (% of total outstanding public notes / bonds held domestically (non-Fed))
BUT WHY WOULD FOREIGNERS WANT US TREASURY DEBT THE US DOESN’T PARTICULARLY WANT?
“Foreigners”, unlike their US counterparts, apparently are under no pressure for higher returns than Treasury’s can provide. Despite yields collapsing, issuance exploding, US trade deficit nearly falling in half, global % of trade in dollars declining…”foreigners” (and the Federal Reserve) increased their holdings of mid and longer duration Treasury’s…and continued holding treasury’s without fear of loss despite 3 separate Federal Reserve halts to their bond purchase programs (QE).
BUT SPECIFICALLY, WHO BOUGHT THE TREASURY’S?
Not surprisingly, China and Japan (combined) were by far our largest creditors and increased their Treasury holdings by net $1.4 Trillion since ’07 on a trade surplus w/ the US of $3+ Trillion over the period. They now (combined) hold just over 20% of all US marketable Treasury debt.
CHINA / JAPAN (treasury holdings)
- ————–> ’00 ————–> ’07 ———–> Mar ’14
- TOTAL –> $375 Billion —-> $1 Trillion —–> $2.45 T (245% increase) ——-> Creditor Rank
- China —–> $60 Billion —-> $400 B ——–> $1.27 Trillion —————————–>(#1)
- Japan —–> $315 Billion —> $600 B ——–> $1.18 Trillion——————————>(#2)
More puzzling, the financier nations of the world (below) similarly had a $1.2 trillion increase in Treasury holdings in the same period although they have only a relative fraction of the Chinese/Japanese trade surplus with the US. These nations now hold 13% of all marketable Treasury debt. Perhaps some suggestion these banking centers are increasing their holdings of “riskless” assets in advance of Basel III’s revised banking regulations may be fair, but these increases seem a bit far-fetched to simply be adding some “high quality liquid assets” in advance of Basel III implementation. Or perhaps Basel III is simply the regulatory push to engage banks in soaking up ever more government debt (since US and much sovereign debt may be held by banks absent any capital reserves for a potential loss, “riskless”) but more typically this would be done within nations (ie, Spanish banks buying Spanish Sovereign debt…not buying the debt of another, lower yielding nation). Further, I openly question if the Fed is somehow facilitating this Foreign Treasury purchasing…while there is plenty of speculation and strong motives, this theory lacks the acknowledgment of the Federal Reserve or hard evidence to prove it.
Still, the meteoric rise in Treasury holdings of relatively small nations such as Belgium, “Caribbean Banking Centers” (aka, Cayman Islands), Luxembourg, and Ireland to become our #3, #4, #10, #11 creditors (respectively) is odd. This deserves some explanations for what’s happening, the sustainability, and the likelihood of Foreigners to continue accumulation in the face of the Federal Reserves “tapering”.
GLOBAL BANKING CENTERS (treasury holdings)
- —————-> ’00 ———-> ’07 —–> Mar ’14
- TOTAL —-> $210 Billion —-> $376 B -> $1.55 Trillion (400% increase) –> Creditor Rank
- Belgium —–>$28 Billion —-> $13 B —> $381 B ———————————–>(#3)
- “Caribbean banking centers”
- —————-> $35 Billion —-> $68 B —> $312 B ———————————–>(#4)
- UK ————> $50 Billion –> $100 B —> $176 B ———————————–>(#8)
- Switzerland -> $18 Billion—> $34 B —-> $176 B ———————————–>(#9)
- HK ————> $39 Billion —-> $52 B —-> $156 B ———————————->(#10)
- Luxembourg -> $5 Billion —-> $60 B —-> $145 B———————————->(#11)
- Ireland ——–> $5 Billion —–> $19 B —> $113 B ———————————->(#12)
- Singapore —> $30 Billion —-> $30 B —–> $91 B ———————————->(#14)
As budget deficits shrink from record highs of $1.4 Trillion (’09) and bottom out at a paltry $500 Billion (est.) in ’14, GDP will continue to weaken minus the stimulus. Simultaneously, the Federal Reserve proposes to taper QE to zero by late 2014. Foreigners should have fewer dollars to recycle thanks to shrinking US trade deficits due to higher domestic oil/gas production and slowing global % of trade in dollars. So, US economy slows and rates rise? Maybe half right, maybe all wrong.
Two questions…1) will the US allow the economy to slow due to decreasing deficits or induce new deficit spending (short answer, count on more spending) and 2) WHO will provide the demand for the Treasury new issuance and the massive existing rollover purchases…and at what rate??? If we simply extrapolated out a couple more years, we’d see Belgium and the Cayman Islands (“Caribbean Banking centers”) challenging for the top US creditor position, potentially surpassing their Asian rivals…and Ireland and Luxembourg likely moving up to #5 and #6 spots. But that’s the trouble with extrapolating the present trend forward. It leaves you with some ridiculous results…but that’s what I would have thought in ’07 had someone suggested Belgium would be our third largest creditor now!!!
Japan has been at this game for 20+ years now and at ever lower rates on their debt, so, if Japan is any sort of precedent for us, then by push or by pull, there will be a buyer for US debt and likely at rates the US government wants to pay (low and going lower). It won’t likely be domestic sources given the low and going lower yields and need for institutional 7-8% returns. This leaves “foreigners” or a re-entry of the Fed in a return of “QE 4, 5, 6, etc”. Easy to speculate but more correctly we’ll wait and watch the TIC reports to determine if “foreigners” maintain the bid for new issuance and increase their holdings…and if so, this may lead to a discussion of how and why it is these “foreign” banking nations buy and hold so much US debt primarily benefitting the US banking system…acting with much the same goals as the Fed. But, if foreigners bail, QE 4 may be an early 2015 offering. Either way, those calling for higher yields are likely to continue their wait in vain.
However, if by chance I’m wrong (again) and interest rates rose to their long term average of a blended 6.2%. Interest payments (half going to foreigners and some large portion of that leaving the US economy) would be almost $1.1 trillion or more than 1/3 of all Federal tax revenue…increasing the interest payment by over $800 Billion would be a larger loss of gross domestic product than the entire ’08 downturn and thus this seems an unlikely voluntary scenario.
Thanks to those of you who read this; your mission (if you accept) is to spread the gospel of economic literacy in the classrooms, boardrooms, and around the water coolers of wherever you may be. Those that glean the basics don’t need be told the troubles we face…they realize early on the contradictions and conundrums. Just offer them the tools and the rest is up to them!
Glad to hear your comments, questions, and/or corrections.
Tags: Economics Economy global rates collapse yeild