Who’s flying the plane?
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If Indeed "History May Not Repeat Itself But It Certainly Does Rhyme," by Mark Twain, is true, why would anyone today buy a 10-Year U.S. Treasury Yielding 1.92 percent today?
The U.S. is poised to run a deficit in the 2011 fiscal year (which ended September 30, 2011) of $1.3 trillion—the third largest in the history. All three record deficits occurred in 2009, 2010 and 2011. And the outlook for improvement is dismal at best with the Congressional Budget Office (CBO) projecting that unemployment will remain in excess of 8 percent until 2014. (Interpret that as no income tax collections from and unemployment benefit payments to 1/12th of the entire U.S. workforce for several years to come).
U.S. federal debt (and this excludes any arguable issues with the trillions of dollars of unfunded liabilities for Social Security, Medicare and Medicaid) totaled $10.7 trillion at the end of 2008, had climbed to $14.8 trillion this past month and is now projected to grow a minimum additional $8.5 trillion by 2021. That works out to $47,400 debt per person currently, or $123,200 per household (assuming 2.6 people—the national average).
Growth in the Federal debt of $8.5 trillion by 2021 assumes the following:
- Interest rates, while they will increase, will rise not much more than historical inflation (and remember that 2/3rds of the $14.8 trillion of existing U.S. debt must be refinanced in the next three years—so any rate increase greater than the expectations between now and then would significantly increase annual interest on the debt and hence the deficit itself)
- There will never again be new federal spending programs UNLESS they are fully funded by new taxes or an existing program is canceled and the revenues are redirected
- The Affordable Care Act (ObamaCare) is fully funded by the taxes included in the original legislation and will never run a deficit nor will there be any additional required tax hikes to fund this program. (more on this topic tomorrow)
Does anyone truly believe these assumptions will hold?
Interest Rates and the Cost of the U.S. Debt
U.S. Treasury rates are now at all-time record lows. September 29th saw the 1-month Treasury (on an annualized basis) yielding 0 percent (yes—zero percent). But it climbed all the way to 0.02 percent by close of the markets on September 30th. Two-year Treasuries were at 0.25 percent, 10-year Treasuries were priced to yield 1.92 percent while the 30-year bonds yielded 2.90 percent. I think you have to question the sanity of an investor that is tying up money today for 30-years at less than 3 percent per year. Why do I say such strong words? The Gross Domestic Product Implicit Price Deflator for the past 30-years pegged inflation at 118 percent. If that rate repeats itself, then not only will the 30-year Treasury note buyers get just a 2.90 percent annual yield, they also will likely get less than half their original investment in real dollars at maturity—assuming that the coming 30-years performs like the past 30-years. As Mark Twain said, “History may not repeat itself, but it certainly does rhyme.”
The CBO’s latest update shows the following expectations for interest rates in the cloning years (and this is critical as these rates will be the foundation for the country’s annual debt costs):
3-Month Treasury 10-Year Treasury
2011 0.1.percent 3.3 percent
2012 0.1 percent 3.2 percent
2013-2016 1.5 percent 4.1 percent
2017-2021 4.0 percent 5.3 percent
These assumptions are included in the following estimated annual interest payments on the U.S. Federal debt, as shown in the following graph (as of August 2011). Why is this important? As with any loan, it’s not the dollar amount that is critical but rather the ability of the borrower to make the periodic payments, and if necessary, as in the case of the U.S. debt which is interest only and does not amortize, to periodically refinance.
Recall that in August 2011, the President stated that unless the debt ceiling was raised the government would not be able to make the interest payments that month. Total projected interest payments in fiscal year 2011 are $438 billion. Now realize that the annual interest payments are projected to almost triple by 2020 to more than $1.1 trillion. And yet we had to borrow money this year to make part of the $438 billion interest payment.
Good news is that the projections for annual interest costs in the coming decade are less than just six months ago. And the bad news? According to the President, we would have defaulted on interest payments on the debt in August had the country not been able to borrow more. Congress remains more focused on campaigning for reelection than trying to reduce government spending. And it seems that no one is flying the plane……they are all campaigning.
Yes—I am spooked, and it’s not even Halloween yet.