Thursday, August 4, 2011

Watch Your Wallet

The debt ceiling limit is behind us.  However, what lies ahead?  It is one thing to have a debt limit but it is another thing to get someone to loan you the money.

Consider this chart that Chris Mayer on Agora Financial put together.  It shows that the United States needs to rollover almost $500 billion of U.S. Treasury debt during August.  It also has to finance a projected $159  billion for the budget deficit in August.  This means that the Feds have to float almost $650 billion of debt in August to keep the federal fiscal shop afloat.

To put that in perspective that is almost the total amount of the QE2 debt-buying (money printing) program of the Fed that ceased at the end of June.  It is also about half of the estimated $1.2 billion in U.S. debt that China holds.  Who is going to fund the federal government and buy all this debt?

The United States actually borrowed an additional $239 billion just yesterday according to this
Washington Times story.  This actually ate up 60% of the $400 million debt limit increase that was signed earlier this week that is supposed to tide us over until the end of the year.  The Treasury was clearly making up for some of the manueverings they did to extend the debt limit into August.  If you recall, the actual limit was actually hit in May.  However, an added $239 billion in additional debt in one day is mind blowing.

Right now Europe seems to be coming unglued.  Italy, Spain, Portugal and Ireland all have huge fiscal problems in addition to Greece.  Of course, the German and French banks are the ones that have the biggest exposures to these debts and this opens up the Germans and French governments as well.  That, in turn, is also bad for the Euro.

US Treasury rates have dropped in the last few days and gold has soared (until today).  There are many Europeans looking for a safe haven right now.  This is an advantage for us at the moment but potential trouble has to lie ahead when you look at the massive amount of debt that has to be rolled over every month.

Companies and countries do not crater because they run out of assets.  They typically hit the wall when a crisis of confidence (even one that might be short term) locks them out of the debt markets when they need to refinance their debt.   This causes a default because they don't have the cash to pay off the debt and don't have the time to liquidate their assets.  This is what caused numerous banks to fail in the 1930's and what brought down Lehman Brothers in 2008.  The road to disaster for any organization is to fund long-term obligations with short term borrowings.  Why?  Because you could very well reach a day when you need to refinance your debt and no one is willing to help on that particular day.  Game over.

Warren Buffett puts it this way...

Borrowers learn eventually that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that's all that is noticed. Even a short absence of credit can bring a company to its knees. In September 2008, in fact, its overnight disappearance in many sectors of the overall economy came dangerously close to bringing our entire country to its knees." 

It is unimaginable that we could not borrow somewhere in the worst case.  However, at what cost?  Italian 10-year bonds were yielding 6.07% yesterday.  Spain was at 6.23%.  The U.S was at 2.595% yesterday and dropped to 2.41% today. 2 year t-bills today yielded .25% today-the lowest ever recorded.  One month t-bills are actually negative thanks in part to an announcement by Bank of New York Mellon that it would begin charging fees for large cash deposits.  It seems that they have had a number of large cash deposits in the last month as large investors lowered their risk profile from foreign currencies, stocks and commodities and moved to cash.

At the same time, stocks got hammered today losing 500 on the Dow despite the debt ceiling deal.  Of course, if the debt limit deal had not been agreed to we would now be hearing it is all the fault of the Tea Party Terrorists.  Who do we blame if we can't blame the Tea Party or Bush now?

We live in interesting times.  Watch your wallet very closely.

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