Wednesday, July 29, 2015

Why rising interest rates may destroy the US national budget

We've spoken many times before about the parlous state of the US government in financial terms.  Most of its programs are funded by deficit spending, borrowing money today to pay for current needs and promising to repay it out of future earnings.  Trouble is, as we've seen, future repayments never happen:  instead, the debt gets bigger, and bigger, and bigger, until . . .

The inimitable Karl Denninger has summed up the effects of such debt levels - and the impossibility of repaying them - in an article today.

You borrow $1,000,000 @ 5% interest on a one-year bond.  You must pay, at the end of one year, $1,050,000.

But you don't pay it off, you just pay the $50,000 interest.  In the meantime, over the next year, the interest rate goes down to 2.5%.

When you roll over the debt you find that your interest on the new bond is now $25,000.  Or, you can borrow another million and pay the same $50,000! 

Guess what you do?

You borrow another million, of course.

Then another year passes.  The rate is now 1.25%.  You can now borrow $4 million for the same $50,000 in interest and not pay any of it off.  Remember, you started with one million but now, you have $4 million to spend!  Huzzah!

There's a wee problem with this -- zero is a lower boundary, and a hard limit.  Therefore, your continued borrowing of more and more money, which allows you to appear to be doing quite well when in fact you are not, must end.  Even if rates don't go up and simply stay pinned near zero, you can't access any more borrowed money because doing so requires that lower and lower rates come every time you renew the bond, and mathematically that must (and now has) come to a stop.

This is why the so-called "economic prosperity" (which was fake, by the way) over the last 30 years happened.  It is particularly where the so-called "recovery" since 2008 happened, all of which was driven by an explosion of non-economic borrowing made possibly by continual rate reductions.

This has now ended and it's why "growth" has disappeared.

But -- if rates rise to, say, that former 5%, you suddenly don't owe $50,000 in interest any more.

You now owe $200,000 each and every year on a permanent basis, or one fifth of the original million you borrowed!

Worse, there is only one way to make that number smaller: You must pay back some or all of the $4 million you have out -- but you spent it!

This is the trap that The Fed, the Government and corporations now find themselves in -- a trap of their own design.

There's more at the link.  Indispensable reading, and 100% accurate.

This is why the enormous debt loads being carried by our Federal, state and local governments, and by so many of our corporations, are like millstones around our collective necks.  They're dragging us all down, as individuals, as a society, as a nation.  Sooner or later we have to deal with them.  It won't be possible to pay them off unless we deliberately 'print' so much new currency that it devalues the US dollar to an unprecedented extent, and causes rampant inflation.  The other option is to default on our debts . . . which will destroy the 'good faith and credit' of the United States.

We're in a cleft stick.  We're caught in a trap of our own devising - and because we elected politicians who pandered to their electorate, and spent all this money, and incurred all this debt, to feather their own nests and ensure their re-election, and because we failed to stop them, we're all going to suffer together.

Look at the size of Federal government debt in the graphic above.  That doesn't tell the whole story.  It doesn't account for future promises - Social Security, Medicare, Medicaid and other programs - that have been promised to us, but for which there's no money in the bank.  (The so-called 'Social Security trust fund' exists in theory but not in practice.  Anyone who tells you otherwise is deliberately lying to you.)  The Federal government's total liabilities, including those future promises, were estimated to total almost $87 trillion in 2012, and (thanks to Obamacare) have been estimated at well over $120 trillion today.  Alan Greenspan noted today that this enormous increase in entitlement spending is 'extremely dangerous'.  State and local governments and US corporations owe an incalculable amount more.  I've seen estimates ranging anywhere from $25 trillion to four or five times that.  Who knows the real numbers?  I've no idea.

How can we possibly fund such outlays?  Where can we find the money?  The answer is simple.  We can't.  There isn't enough money in the world to fund them.  That's the cold, hard fact.  If you were relying on Social Security and Medicare for your retirement, the odds are pretty good that they won't be there for you:  or, if they are, they'll be paid in deliberately inflated dollars that won't be worth anything like what you expect (which is already happening;  see Sprott Money's analysis in this article - scroll down to read it).

Hang on to your hats, folks.  It's going to be a bumpy ride . . . and it's not going to be fun.



Henry Vogel said...

I have wasted a fair bit of time arguing about the Social Security "trust fund" over the years. It's amazing how many people simply can't get beyond arguing the trust fund is "safe" because it's held in the form of government bonds. Of course, only the government can buy those bonds, but they just can't see the problem in that situation.

I've tried explaining it with an example using their personal savings account and IOUs -- every time you take money out of the savings account, you write yourself an IOU (which you call "personal bonds"). If you start with $10,000 in savings but, a year later have replaced the money with $10,000 in personal bonds, do you have $10,000 more than your yearly income or $10,000 less? While people generally understand that example, they always come back to "But with Social Security it's the government!"

Argh! (A word I used a lot back in my comic book writing days which is uniquely suited to this sort of head-against-the-wall level of frustration such arguments cause.)

Uncle Lar said...

The way I like to describe what our government has done to the Social Security trust fund is that it is the moral equivalent of mom and pop borrowing the kid's college money to buy beer and smokes, leaving paper IOUs in place of the cash.
Now it's time for college and all junior has is a stack of those IOUs. And since mom and pop could not seem to live within their means before, what is the likelihood they will pony up the cash to pay for junior's college now?
Way it used to work was all that lovely money came in from all those hard working Americans' payroll deductions. A lot of it was paid back out in benefits, and the rest went into the general fund while its equivalent in US bonds was placed in the SS trust fund. Over time the book value of the trust fund became enormous. And congress got a very nice influx of cash to play with, do "good work" with, reward their friends, and feather their own nests. Then low and behold somewhere about a year or so ago we reached a tipping point where the funds coming in no longer covered the benefits being paid out. No problem of course just tap that trust fund. Of course the only thing in that fund is US bonds that have to be cashed in to cover Social Security's obligations. And the mechanism to do that is to draw from the general fund. So the entire Social Security Ponzi scheme turned from a cash cow into a money pit.
And that is why no one working in DC likes to talk about Social Security.