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Another crack in Republic’s foundations: not the size of the debt, but when it’s due

30 October 2009

There are so many fractures in America’s foundations it’s easy to lose track.  One is subtle, not like to cause problems — but in a crisis it could became a major or even terminal factor:  the maturity structure of the Treasury’s debt.

To save money as the debt has more than doubled since 2000, the government has shortened the average maturity of the debt by almost 1/3 (shorter loans usually have lower interest rates).  As the net public debt nears $8 trillion, this becomes risky.  As in this quiet warning to the Secretary of the Treasury from the folks who sell the bonds:

In fact, with the coupon calendar currently in place, the average maturity of issuance now exceeds the average maturity of marketable debt outstanding. This suggests that the decline in the average maturity of debt outstanding that that we have witnessed over the past seven years – from a high of approximately 70 months in 2000 to a low of approximately 50 months earlier this year should be arrested and begin to slowly lengthen going forward.

— “Report to the Secretary of the Treasury“, Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association, 5 August 2009

Go here to see the growth in the Federal debt over time.

Esp noteworthy is the shift in maturity of debt under 4 years. While this remained at 66% of total marketable debt during the 2005-2008 period, the % maturing within one year went from about 33% to 45% from 2007-09 (from “Tomorrow’s burden“, The Economist, 22 October 2009):

20091022-Economist-Debt

(update)  We’re talking big money, even for the US government.  From “Observations On The US Government’s Escalating Near-Term Funding Mismatch“, posted at Zero Hedge, 1 November 2009.

20091101-Tbills

Why this is a potential problem?

Considers two scenarios if the US has a currency crisis, a solvency crisis, or some other financial stroke. 

(1)  We’ve borrowed $14T, one year’s national income, but financed it all with 30 year bonds.  The interest bill would be large, at 6% equivalent to roughly 1/3 of the Federal government’s revenue.  But only 3% must be rolled over every year.  In a crisis we might lose the ability to borrow (painful), but the debt remains manageable.  Also increases in interest rates affect us slowly, as the 3% of the debt rolls over annually.

(2)  We’ve borrowed $14T financed with 1 year bonds.  The interest bill would be far less, but any crisis threatens the government’s solvency:   bankruptcy, hyperinflation, and revolution would be our choices.  Also, a rise in rates immediately increases the interest cost.  Even if we manage to roll the debt in a crisis, the rise in rates alone might prove catastrophic.

With an average maturity of only 49 months, and almost half due in the next year, we are far too close to the second scenario.  Fixing this will be difficult, expensive, and slow, esp when running large deficits.  Will the market accept extraordinary issuance of long bonds?  At what interest rates?

How did we get into this mess?

We the people, though our government, borrowed with no thought of repaying it.  Treating borrowed money as free money was stupid.  Slow and stupid are the two sins most frequently punished by God (why that is I leave for wiser heads to explain).

Solutions

Triage.  The day is late, and drastic steps have become necessary.

  1. Renegotiate the debt as soon as possible, as our position will likely weaken over time.  Extent maturities.  There will be a price to be paid for this.
  2. Use government funds as need to maintain the economy until it recovers, but spend only to mitigate the suffering and invest in projects that provide an economic return for the overall economy (capturing as much of that as possible for the government, through ownership or loans).
  3. As the economy recovers, cut government spending as fast and deeply as possible.

For details see these posts:

  1. A solution to our financial crisis, in 3 steps
  2. Stabilize the financial system.
  3. Stabilize the economy.
  4. Arrange long-term financing for steps #1 and #2 with our foreign creditors.

For more information from the FM site

To read other articles about these things, see the FM reference page on the right side menu bar. Of esp relevance to this topic:

Reference pages about other topics appear on the right side menu bar, including About the FM website page.

Afterword

Please share your comments by posting below.  Per the FM site’s Comment Policy, please make them brief (250 word max), civil and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

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11 Comments leave one →
  1. Pluto permalink
    30 October 2009 2:27 am

    FM, all of your suggestions are good but require foresight and self-discipline which are probably beyond the government at this time.

    I note that you’ve failed to mention the last, worst, and most likely “solution” to the problem:

    4. Just keep running the printing presses until bread costs $100 a loaf. Although our economy would be in shambles, the public debt would be relatively small and easily repaid (but I don’t think the bond holders would be very happy with the relative return on their investment).
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    Fabius Maximus replies: I disagree with two sentences in your comment.

    “require foresight and self-discipline which are probably beyond the government at this time.”

    I strongly disagree, but can cite no evidence. I have faith in the American people.

    “the last, worst, and most likely “solution” to the problem:”

    * Hyperinflation would not be the last solution. Societies almost always survive hyperinflation (it’s easlily fixed). The classic case, the Weimar Republic, survived over 9 years after curing its hyperinflation (November 1923 until Hitler sworn in as Chancellor on 30 January 1933), done in by the Great Depression.
    * Hyperinflation is certainly not the worst outcome. Its and easy way to go. Read accounts of the German hyperinflation in “Before the Deluge” by Otto Friedrich, or the Austrian hyperinflation in The World of Yesteday by Stefan Zweig. It’s like a big shot of heroin. Debt deflation is far more painful.
    * Nobody can say what’s most likely, and there are many ways we can ruin the Republic. IMO (guessing) a deflationary collapse is more likely than hyperinflation, if only because so many people predict hyperinflation. The most widely feared danger seldom happens, while the obvious but invisible one strikes.

    Like

  2. Honest Question permalink
    30 October 2009 2:32 am

    Fabius Maximus – just wondering: are you of ethnic Jewish descent, either partially or wholly?
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    Fabius Maximus replies: No, not during the past 2 generations (all I know). Given the disorder of Europe during the past millenia or two, anything is possible before that. Does anyone know of any genetic studies about on the ancestry of western europeans?

    Like

  3. 30 October 2009 4:36 am

    The difference between debt deflation and hyper-inflation lies partly in who’s ox will be gored. Debt deflation is primarily a bankruptcy path through piece meal debt repudiation. The damage is terrible because important real economy actors; small business, the young (borrowing for education), venture investors, basically those who look to the future for growth and opportunity whither under an otherwise inescapable debt load.
    Inflation on the other hand devastates the old who live on fixed incomes, and who simultaneously care little about long term growth or investment opportunity. In Japan, politico’s were blocked from inflating by the threat of retaliation from the elderly. They muddled through instead, managing the sagging of their real economy under an increasing debt load decade after decade. We may be about to do the same, it depends on whether the boomers will be willing to take one for the team.
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    Fabius Maximus replies: All true, but it’s more complex.

    Broadly speaking, deflation destroys debtors — which is much of the middle and upper middle classes. Lacking capital, they acquire productive assets (e.g., farms, business equipment, buildings, land) — and homes. Mild inflation (e.g., the 1970’s) is wonderful for them. Hence their antipathy with the 19th century US gold standard (William Jennings Bryan: “You shall not crucify mankind upon a cross of gold“). If broad and long enough, it destroyes both businesses and banks. It’s difficult to cure. Fortunately it’s very rare, so this is mostly theory. Fisher “debt deflation” is the problem today; see this post for a detailed analysis. The wealthy with little debt are the big winners, unless this causes a revolution.

    Inflation has a much clearer set of winners and losers. To oversimplify, debtors with fixed interest rate loans are winners. Their creditors are losers. Since the biggest financial asset of the middle class are bonds (including bank accounts and CDs), their wealth goes up in smoke. People who have fixed assets and fixed rate mortgages do fine. If wages keep up with prices, life goes on (see Brazil). If not, society collapses. Inflation is a varied animal, and can play out in many different ways. The most important aspect is that it’s relatively easy to cure. Hence the major central banks eagerness to induce inflation rather than risk debt-deflation.

    Like

  4. Mikyo permalink
    30 October 2009 5:23 am

    Whatever is beyond the ability of the current government, we may still try to do for ourselves :)

    Like

  5. Mikyo permalink
    30 October 2009 5:29 am

    “The road must be trod, but it will be very hard. And neither strength nor wisdom will carry us far upon it. This quest may be attempted by the weak with as much hope as the strong. Yet such is oft the course of deeds that move the wheels of the world: small hands do them because they must, while the eyes of the great are elsewhere”
    — by Elrond, in Lord of the Rings

    Like

  6. joey permalink
    30 October 2009 9:56 am

    The biggest danger with hyper inflation is it destroys savings, combined with unemployment it has the effect of forcing large numbers of middle class voters to the wall. With unforeseeable effects.

    Actually the Nazi regime was extremely weary of inflation, hyper or other wise, and instigated a system of price controls to hold it down, at great cost those continued to the end of the war, see the “Wages of Destruction, the making and breaking of the nazi economy“.

    The trauma of hyperinflation never left Germany, and still echos today, in the mandate of the European central bank.
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    Fabius Maximus replies: Most commentary about inflation/deflation reflects the key but overlooked fact: sustained inflation is painful, common, and easily cured (only the will to do so is required). Sustained deflation is potentiall lethal, very rare, and difficult to cure.

    Like

  7. Pluto permalink
    30 October 2009 11:19 am

    I understand your hesitation to expect inflation given the deflationary pressures the economy is currently facing so I will briefly explain my logic.

    So far the government has faced the deflationary challenges by rapidly expanding the money supply, which is currently being offset by debt destruction. The government is signaling that it wants to stop expanding the money supply because it believes that the crisis is either nearly over or is over and it wants to avoid inflation.

    This will not happen for any length of time because the deflation problem (which is much larger than the crisis but is spread out over time rather than being a single obvious event) isn’t over yet. The deflation problem will force the government to start the rapid expansion of the money supply again by the middle of next year at the latest.

    Once you start down the “expand the money supply” trail it is hard to stop. It is too easy for the government to see this as a solution to all of its financial problems.

    In the worst-case scenario, we find ourselves in a Nixon-like situation; trying to expand the money supply faster than the rate of inflation, not realizing that the inflation rate is caused by the expansion of the money supply. I doubt we will fall to quite that depth simply because it’s been done before and the results were well-documented and ugly.
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    Fabius Maximus replies: My objection is more fundamental. Broad macroeconomic forecasts are almost never correct. Our theory is inadequate, the world too complex. Hence confidence in such things is inappropriate, IMO.

    Like

  8. 30 October 2009 4:17 pm

    On the question of the ancestry of Europeans (and I, too, am descended from Europeans) – see “Estimating the Impact of Prehistoric Admixture on the Genome of Europeans“, published in 2004 in the journal Molecular Biology and Evolution, by Isabelle Dupanloup et al.

    “…[M]ost current populations can be regarded as the result of a hybridization process among four or less potential parental populations. Two main components are apparent in the Europeans’ genome, presumably corresponding to the contributions of the first, Paleolithic Europeans, and of the early, Neolithic farmers dispersing from the Near East. In addition, only a small fraction of the European alleles seems to come from North Africa, and a fourth component reflecting gene flow from Northern Asia is largely restricted to the northeast of the continent. The estimated Near Eastern contribution decreases as one moves from east to west, in agreement with the predictions of a model in which (Neolithic) immigrants from the Near East contributed a large share of the alleles in the genome of current Europeans….”

    .
    FM reply: Great material. Thank you for posting this!

    Like

  9. Greg L permalink
    30 October 2009 4:35 pm

    Take a look at {this page from Fed’s Flow of Funds Statement}. It is a tally of US debt. When we hit the Reagan years the numbers start to snowball. It didn’t seem to matter who was running the show. Liberal or conservative, Dem or Repub, the numbers just get bigger and bigger.

    So okay, lets just get rid of the bums in DC and replace them with US. US will probably do the same thing they did. US will hire our friends and relatives. US will give tax breaks, subsidies, grants, and sweetheart contracts to our patrons. Finally US will go running to K street with our hands out so we can get reelected and do it all over again. This mentality will not likely change until the credit gets cut off. We must be of some use to the rest of the world. Why else would they keep giving US money to continue on as we do?
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    Fabius Maximus replies: When you point with one finger, 3 point back at you. The government officials — President, Treasury Department, and Fed — have changed many times since 1982. Both parties have controlled both houses of Congress and the White House. So the problem does not lie there.

    The common element is us. We the people. So we must be the guilty party. When we can accept responsibility for what has happened, then we will be ready and able to properly govern America.

    I’m Gonna Make A Change
    For Once In My Life
    It’s Gonna Feel Real Good
    Gonna Make A Difference
    Gonna Make It Right…

    I’m Starting With The Man In The Mirror
    I’m Asking Him To Change His Ways
    And No Message Could Have Been Any Clearer
    If You Wanna Make The World A Better Place
    Take A Look At Yourself, And Then Make A Change

    — Michael Jackson’s “The Man in the Mirror

    Like

  10. Steve Ward permalink
    30 October 2009 6:24 pm

    Genetic testing is available through the National Geographic genome project. Also produced a very interesting TV show. {See the genographic project at the National Geographic website.}

    Like

  11. anna nicholas permalink
    30 October 2009 11:09 pm

    I thought they reckon we all came from Africa 150-50,000 yrs ago .
    Bushmen , Karen , Zionists , Inuit , Aryans , all African .
    I think that is such a brilliant, sardonic,triumphantthing , and hope it is true .

    Like

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