Saturday, August 5, 2017

Is this the trigger for the next economic crisis?


Alan Greenspan has a dire forecast for the US bond and stock markets, one that would threaten world financial markets as well.

Former Federal Reserve Chairman Alan Greenspan issued a bold warning Friday that the bond market is on the cusp of a collapse that also will threaten stock prices.

In a CNBC interview, the longtime central bank chief said the prolonged period of low interest rates is about to end and, with it, a bull market in fixed income that has lasted more than three decades.

"The current level of interest rates is abnormally low and there's only one direction in which they can go, and when they start they will be rather rapid," Greenspan said on "Squawk Box."

. . .

"I have no time frame on the forecast," he said. "I have a chart which goes back to the 1800s and I can tell you that this particular period sticks out. But you have no way of knowing in advance when it will actually trigger."

One point he did make about timing is it likely will be quick and take the market by surprise.

"It looks stronger just before it isn't stronger," he said. Anyone who thinks they can forecast when the bubble will break is "in for a disastrous" experience."

There's more at the link.

I've mentioned this problem on several previous occasions, but it bears repeating:  the US government's expenditure is funded, to a very large extent, by the sale of Treasury securities ('bonds').  At present, there are literally trillions of dollars of such bonds outstanding (you can check the current and historical figures here).  They were mostly sold at very low rates of interest.  As they fall due, the Treasury usually issues and sells new bonds to replace them, effectively 'recycling' the bond rather than paying off the debt.

If the newly-issued bonds have to be issued at a higher rate of interest, in order to attract buyers, it would have an immediate and dramatic impact on the US budget.  In 2016, the US Treasury paid out no less than $432,649,652,901.12 (for convenience, let's round it to four hundred and thirty-three billion dollars) in interest.  That's money that had to be raised from taxes, or new bond sales, or interest earned on investments.  It's a mandatory payment.  If the USA ever stopped paying the interest it owes on its financial instruments, the so-called "full faith and credit" of this country would become a risible, meaningless joke.

If interest rates rise by (say) 50%, the amount of interest that has to be paid will rise in the same proportion, as new bonds are issued (at the higher rate of interest) to replace older, lower-interest bonds that fall due.  If interest rates double (not at all unlikely, given their present deliberately and artificially low levels), the interest paid every year will soon double, too . . . but there is no spare cash in the US budget to pay those amounts.  The only way it can be paid will be to cut other expenditure, including entitlement programs such as Social Security, Medicare, Medicaid, etc.

That's why the bond market is such a big deal;  and that's why Mr. Greenspan is so worried.  We should be, too.  He knows whereof he speaks.

Peter

7 comments:

TheOtherSean said...

We could sell California (or parts thereof) to raise funds to pay off some of the underlying debt, to reduce interest rates. Or perhaps Japan would like to make a bid on the Aleutians - they expressed interest of sorts during the 1940's.

Seal Of Lion said...

At this point you usually hear people say that we don't have to pay them back. We could just default on them and go about our business as before.

I'm no economist but even I know you can't default on even a percentage of what's out there without a class 11 scale earthquake happening.

Uncle Lar said...

As I've mentioned before, Social Security now operates at a net loss. They pay out more in benefits than they take in from payroll deductions every year. So the difference must be made up out of the so called Social Security lock box. Thing is, there is no money in that box at all, every penny is in T-bills. The actual cash which came from running at a surplus for many years was taken, spent on congressional largess, and replaced with US paper IOUs.
A return to historical interest rates in the 4-5 percent range would cripple the economy in general and Social Security in particular. Those cans they have been kicking down the road so many years are about to be run over by a steam roller.

Chuck Pergiel said...

Interest rates are low because there is a great deal of money out there in the hands of people who are deathly afraid of losing it in some venture capital gamble (like stocks), so they put it in something safe, like bonds. Capitalism has been very successful, for the capitalists. They have made so much money they don't know what do with it, so they buy bonds. Until people start gambling with that money (investing it in some sort of business), the amount of money going into bonds will remain high and interest rates will remain low. And while interest rates are low, they could go lower. In Europe last year interest rates even went negative, which shocked the stuffing out of me.

Ray said...

The word missing above is the deficit. If we can get back to regular growth levels that will help a lot. Another option not mentioned is inflation. Interesting times ahead...

Dan said...

This certainly would not be new and for those of us who are older it isn't news.
I remember clearly when the prime rate was over 18%, mortgages rates were as much as 20% and it wasn't uncommon to pay 25% interest on car loans. The economy at that time under Carter was stagnant....and that's being kind. No reason it can't happen again....and be even worse.

Nitzakhon said...

I used several excerpts from your essays on this topic. Thank you for the material!

http://obamasez.blogspot.com/2017/07/running-out-of-financial-road.html

Nitzakhon