News
The U.S. Government finances its massive spending in three ways.
It collects revenues from taxes, tariffs and other income sources. It borrows any shortfalls from investors through the issuance of its IOUs commonly referred to as U.S. Treasuries.
Lastly, it can create money from thin air through a process called “Quantitative Easing” (QE). This third process, QE, issues treasuries to another branch of the U.S. Government, the Federal Reserve, in essence, loaning money to itself.
The more a government overspends the more it has to borrow. The more it borrows, the riskier that government is perceived as it relates to its ability to pay off its debt. Much like a bad brother-in-law writing checks and IOUs all over town, the more debt that is issued, the higher the perceived risk of default.
When countries continually increase their borrowing, much like a compounding credit card, the interest that has to be paid on that debt grows ever larger, eventually necessitating a vicious cycle of paying off old debt by issuing new debt.
The eventual end game of this “refinancing” comes when those doing the lending get the idea that the IOUs they hold will never be paid. In the equities and treasury markets, this fear of default is reflected by higher interest rates. Investors, perceiving increased risk by the borrower, demand higher interest payments to compensate them for the increasing risk.
The world debt markets work the same way. When a government exhibits the propensity to run higher and higher deficits, the interest rate it has to pay on its debt rises in order to entice investors to continue to loan it money.
Eventually, interest rates go so high that governments can no longer afford to borrow at these higher rates and a partial or total default takes place, leaving the holders of all that debt literally “holding the bag,”
Economic history maintains a perfect record when dealing with overspending governments. The result is always rising interest rates, followed by massive inflation, eventually leading to total or partial default by the borrowing country.
The debt is then defaulted on, either partially or entirely. The debt holders receive pennies on the dollars, if anything at all, and the unfortunate citizens of that country lose most of their wealth through loss of purchasing power because their currency collapses.
Fast forward to today's treasury market and we find an interesting conundrum taking place. The U.S. leads the world in deficit spending.
The 2010 U.S. deficit is expected to run over $1.5 trillion, not including its unfunded liabilities (promises of future payments) which, when added in, makes the 2010 deficit close to $2.5 trillion.
Considering it took us 225 years to run up the first $8 trillion in debt, this year's $2.5 trillion seems inconceivable but true.
Yet, in the face of this massive U.S. debt issuance, interest rates on U.S. treasuries are at an historic low. Either economic fundamentals have been suspended or something else is going on.
What is likely happening here is the perception by investors that U.S. treasuries are still the safest investments in the world based on the fact that the U.S. is the largest economy in the world and that the U.S. dollar is used as the primary currency for most of the world's transactions.
In essence, we have been given a temporary free pass. A total or partial default by the U.S. is regarded as inconceivable and since U.S. treasuries are still thought of as safe, large investors are buying U.S. treasuries instead of stocks and other equities.
In light of how much the U.S. owes already, it begs the question — why? Investors obviously perceive there is still risk in the stock and equity markets in order for them to settle for almost zero return on U.S. Treasuries.
It becomes clear that the smart money is more worried about the return of their money than the return on it.
By willingly buying U.S. treasuries at these historically low returns, they are shouting from the rooftops that they still see risk in the stock markets. If the smart money is weary of the equity markets, perhaps we should be, too.
In conclusion, are U.S. treasuries really the safest investments in the world and are these smart investors really that smart?
If history is any example, you have to wonder. Unless the U.S. gets its financial house in order, stops its incessant borrowing and curbs its spending excesses, those smart money investors buying these supposedly safe U.S. treasuries could end up hold
It collects revenues from taxes, tariffs and other income sources. It borrows any shortfalls from investors through the issuance of its IOUs commonly referred to as U.S. Treasuries.
Lastly, it can create money from thin air through a process called “Quantitative Easing” (QE). This third process, QE, issues treasuries to another branch of the U.S. Government, the Federal Reserve, in essence, loaning money to itself.
The more a government overspends the more it has to borrow. The more it borrows, the riskier that government is perceived as it relates to its ability to pay off its debt. Much like a bad brother-in-law writing checks and IOUs all over town, the more debt that is issued, the higher the perceived risk of default.
When countries continually increase their borrowing, much like a compounding credit card, the interest that has to be paid on that debt grows ever larger, eventually necessitating a vicious cycle of paying off old debt by issuing new debt.
The eventual end game of this “refinancing” comes when those doing the lending get the idea that the IOUs they hold will never be paid. In the equities and treasury markets, this fear of default is reflected by higher interest rates. Investors, perceiving increased risk by the borrower, demand higher interest payments to compensate them for the increasing risk.
The world debt markets work the same way. When a government exhibits the propensity to run higher and higher deficits, the interest rate it has to pay on its debt rises in order to entice investors to continue to loan it money.
Eventually, interest rates go so high that governments can no longer afford to borrow at these higher rates and a partial or total default takes place, leaving the holders of all that debt literally “holding the bag,”
Economic history maintains a perfect record when dealing with overspending governments. The result is always rising interest rates, followed by massive inflation, eventually leading to total or partial default by the borrowing country.
The debt is then defaulted on, either partially or entirely. The debt holders receive pennies on the dollars, if anything at all, and the unfortunate citizens of that country lose most of their wealth through loss of purchasing power because their currency collapses.
Fast forward to today's treasury market and we find an interesting conundrum taking place. The U.S. leads the world in deficit spending.
The 2010 U.S. deficit is expected to run over $1.5 trillion, not including its unfunded liabilities (promises of future payments) which, when added in, makes the 2010 deficit close to $2.5 trillion.
Considering it took us 225 years to run up the first $8 trillion in debt, this year's $2.5 trillion seems inconceivable but true.
Yet, in the face of this massive U.S. debt issuance, interest rates on U.S. treasuries are at an historic low. Either economic fundamentals have been suspended or something else is going on.
What is likely happening here is the perception by investors that U.S. treasuries are still the safest investments in the world based on the fact that the U.S. is the largest economy in the world and that the U.S. dollar is used as the primary currency for most of the world's transactions.
In essence, we have been given a temporary free pass. A total or partial default by the U.S. is regarded as inconceivable and since U.S. treasuries are still thought of as safe, large investors are buying U.S. treasuries instead of stocks and other equities.
In light of how much the U.S. owes already, it begs the question — why? Investors obviously perceive there is still risk in the stock and equity markets in order for them to settle for almost zero return on U.S. Treasuries.
It becomes clear that the smart money is more worried about the return of their money than the return on it.
By willingly buying U.S. treasuries at these historically low returns, they are shouting from the rooftops that they still see risk in the stock markets. If the smart money is weary of the equity markets, perhaps we should be, too.
In conclusion, are U.S. treasuries really the safest investments in the world and are these smart investors really that smart?
If history is any example, you have to wonder. Unless the U.S. gets its financial house in order, stops its incessant borrowing and curbs its spending excesses, those smart money investors buying these supposedly safe U.S. treasuries could end up hold
