A Street Car Named Treasuries
In the 1947 Tennessee Williams play “A Streetcar Named Desire“, as she is being carted off to the mental institution, Blanche Dubois utters these famous words …“I have always depended on the kindness of strangers.”
And like Ms. Dubois, the United States has also come to depend on the kindness of strangers to fund a massive $18.3 trillion in debt.
But that kindness the US Treasury has come to depend upon may be waning. Foreign holdings of U.S. Treasury securities fell in May for a second straight month. The Treasury Department reported total holdings were down 0.1% in May to $6.13 trillion. This comes after an even bigger 0.6% decline in April.
In four of last six months, China has been a net seller of Treasuries. According to Bloomberg, China sold $180 billion worth of treasuries from March of 2014 to May of this year. China had $1.65 trillion worth of Treasuries at the peak, now they have $1.47 trillion. And Japan also sold $9.4 billion of long-term treasuries in June alone.
With foreign investment demand waning the US may have a harder time funding its debt. The US savings rate is currently around 5%, that is less than half what is was in 1980 and a full 8 percentage points below its level at the end of the Bretton Woods Era. This begs a question: who will be a buyer of our debt if foreign governments stop buying and even become sellers? The answer of course will eventually be a protracted and unlimited amount of Treasury purchases on the part of our central bank.
Adding to this uncertainty is the Fed’s retreat from QE. We can no longer count on the Fed buying $45 billion per month of long-term Treasuries. And now the Fed is promising to start slowly unwinding its $2.5 trillion of government debt.
How will the lack of demand for the Treasury affect interest rates?
The average yield on the 10 year was over 7% between the years starting in 1971 and the start of Great Recession. However, Central Banks have been actively pushing down the long end of curve for the last seven years. Thus, lowering interest rates and making our massive federal debt easier to service and much more readily increased.
In fact, the CBO projects annual deficits will rise north of $1 trillion within 10 years, which at that time will equal 4% of GDP. This annual increase of one trillion dollars will rapidly pile on top of the already dangerous and unprecedented level of publicly traded debt of $13 trillion.
CBO further projects real GDP will grow by about 3% in 2015 and 2016; and by nearly 2½% throughout the next decade. This rosy scenario does not allow for any economic contraction whatsoever during the next 10 years; despite the fact we are already very far along on this current business cycle. In addition, the projected 2.5-3% growth is also above the 2% average GDP growth experienced since 2010.
The looming burden of entitlement programs is already baked into the demographic cake. Once a source of funding for the deficit, Social Security’s main program ran a $39 billion deficit in 2014. This closed out five years of consecutive cash-flow deficits as the program’s unfunded obligations continue to grow. The 75-year unfunded obligation of the Social Security OASI Trust Fund is $9.43 trillion, a $70 billion increase from last year’s unfunded obligation of $9.36 trillion, according to the 2015 annual Trustees’ Report. After including federal debt obligations that are actually recorded as assets to the Social Security trust fund of $2.73 trillion, Social Security’s total 75-year unfunded obligation is close to $12.2 trillion. In fact, the Social Security and Medicare Boards of Trustees’ report shows that both Medicare and Social Security have unfunded liabilities of $50 trillion. That means we need that amount of money sequestered and growing today in order to meet long-term liabilities.
Of course, there is nothing but more IOUs in any of the government’s trust funds. Therefore, these programs act as a drain on the budget the moment tax revenues become less than expenditures.
For the past seven years growth has been anemic and will fall sharply along with the next inventory liquidation that is now overdue. Odds are this next economic contraction will be of the depression variety due to the unsustainable condition of record low interest rates and asset bubbles that must soon burst.
Hence, the notion that we will be able grow our way out of this debt load is pure fantasy-especially in light of dysfunctional governments.
This should be proof positive that the Fed’s inflation quest is pure folly. Growth comes from productivity improvements, not from money printing-a lesson that Keynesian central bankers are either blind to or are purposely ignoring in order to supply an excuse for endless debt monetization. But even with massive manipulation of free markets we are on track for an unprecedented spike in Treasury bond yields due to inflation, insolvency… and now the lack of foreign demand.
The primary purchasers of US debt have been Japan and China. Yet these nations now face their own domestic economic turmoil and will no longer be able to supply a bid for US debt. In fact, China’s $3.6 trillion in currency reserves may be needed to support a Yuan that falls faster than what the PBOC has recently desired. Since China and Japan have become sellers of Treasuries the Fed will have to step up the buying. However, as previously indicated, our central bank has promised to join in on the hit-the-bid parade starting this year. Ms. Yellen is aware interest rates cannot rise very far from the current levels without crippling the bubbles in equities, real estate and the economy as a whole.
In order to combat the next deflationary collapse of the economy, which has already started to engulf the globe, the Federal Reserve will soon have to join in the current currency debasement derby that is being led by China, Europe and Japan. This means the Fed will not only stay near the zero-bound range on interest rates, but will most likely launch another round of QE in the near future. At that point all central banks will be on a full on assault to depreciate the value of their fiat currencies.
Incredibly, gold mining shares are trading at 15 year lows despite record levels of debt and an unprecedented increase in the size of central bank balance sheets that have exploded for the expressed intent to boost the level of inflation. This has set the stage for the next major bull market in gold mining shares that will be starting from prices not seen since the start of last millennium.