Sunday, July 24, 2016

Debt and Destiny

The debt of the U.S. federal government debt currently is $19.4 trillion and it continues to rise by the minute.

Debt has doubled in the last eight years as this graph from the Federal Reserve of St. Louis shows.

Who holds all of this debt?

$5.4 trillion of the debt is referred to as intragovernmental debt. These debt holdings result when various government trust funds, revolving funds and special funds lend money to the federal treasury to fund current operations. The remaining $14 trillion is referred to as public debt and is held by individuals, corporations, mutual funds, the Federal Reserve, state and local and foreign governments.

The largest holder of intragovernmental debt holdings is the Social Security Trust Fund which accounts for about half of the total amount. In effect, over the past 30 years Social Security has collected $2.8 trillion of additional taxes over and beyond what it has paid in benefits. These amounts were "lent" to the federal government which used it to pay for everything from food stamps to B-1 bombers. In turn, the Federal Treasury gave a paper IOU to Social Security. The money is gone but the federal government still owes the money and it is time to pay the piper.

Social Security will now need to begin "calling their loans" to the federal government to be able to balance the emerging shortfall between FICA tax collections and benefit payments to retirees. It is expected that the entire $2.8 trillion in "loans" will need be collected between now and 2034.

The chart below shows how quickly those "reserves" are projected to be spent. Of course, the federal government does not have anything to pay the Social Security Trust Fund off with. This money has to come from additional federal taxes or additional borrowings from public holders of the debt.

If this is not sobering enough, another $1.5 trillion is owed to the federal employee and military retiree systems. There are a lot of tax increases in our future! Millennials take note. You will bear the brunt of these taxes during the remainder of your working years. Choose your elected officials wisely.

Source: 2016 OASDI Trustees Report 

Who holds the $14 trillion of public debt?

Here is the breakdown as of 12/31/15.

Foreign interests- $6.2 trillion. Almost half of the total. China is the biggest holder followed by Japan

Federal Reserve- $2.5 trillion

Mutual funds-  $1.2 trillion

State and local govt- $.8 trillion (includes public sector pension plans)

Banks- $.5 billion

Private pension plans- $.4 billion

Insurance companies- $.3 billion

U.S. Savings Bonds- $.2 billion

It is both interesting and troubling to me that $8.7 trillion of $14 trillion of our debt (62%) is in the hands of foreign interests and the Federal Reserve.

Almost all of the Federal Reserve's holdings of debt have occurred in the last eight years as part of its quantitative easing program. Foreign buyers of our debt have been ready buyers of our debt in recent years as the central banks of many countries have resorted to negative interest rates (who thought that I would ever be uttering that phrase) in an attempt to create economic growth.

To provide some perspective on how pervasive negative interest rates have become around the globe, consider this graphic.  In fact, more than one-third of all sovereign debt in the world pays negative interest. Switzerland's 50 year bond recently fell below ZERO! It is incredible and defies all rules of economic logic.

However, the United States is currently benefitting from what is going on in the rest of the world. Even though the yield on the Treasury's 10-year bond is hovering around 1.6% right now, it still is a lot more than zero. Combined with our reputation as a safe haven for money it makes it easy for the United States to find investors that will extend credit to us.

However, what happens when all of this turns? And it will turn at some point.

6,000 years of economic history prove that. Borrowers are being paid less for the risk they take in loaning their money than at any period in human history. It is truly unprecedented. For perspective, look at this graph showing long-bond yields in the U.K. from 1750 to 2014. By the way, the current 10 year yield on the UK government bond is .8% which would put it below the horizontal base line (@1%) on the graph below.

The United States also has an average debt maturity that is shorter than all the major European countries. That means that the United States could find itself facing significant refinancing risk if the current environment changes in addition to the risk it faces of having to bear higher interest costs on the debt.

Our destiny is inextricably tied to our country's debt. And that debt load is inextricably dependent on foreign interests and funny money from the Federal Reserve to keep the economic system working. It all continues to work... until it doesn't.

I don't know when or how it will turn or end. However, we will all be in deep do-do when it does.

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