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Charting The US Treasury's Toxic Debt Spiral (And Get Ready For GDP-Linked Bonds)

Tyler Durden's picture


The recently released Presentation to the Treasury Borrowing Advisory Committee (consisting of a 13-member committee of bond dealers and
investors that meet quarterly with Treasury officials), which somehow managed to slip by under the radar, is a must read for anyone curious about the funding ability of the US government. A closer examination (and it is chock-full of must read observations) reveals far more conclusively than whatever today's budget myth may reveal, the US is truly in a dead-end situation, and that there is no way the Fed can now possibly step away from indefinite future debt monetization. And the stunner that nobody has yet mentioned: the US is actually considering GDP-linked bonds: the last recourse of a country about to go bankrupt.

Some of the key charts:

Cutting straight to the chase, interest expense on the US debt, which in 2010 was below $200 billion is expected to jump to $800 billion in 2020. Luckily, the Fed will own pretty much all the debt by then, meaning the shell game will be in full force, with all interest due to bondholders promptly remitted back to the Treasury. A Ponzi scheme by any other name...

And the immediate follow up: the exponentially increasing debt target, er, ceiling:

After average debt maturity hit a 23 year low recently, it has since jumped to the highest since 2003.

The reason for the increase in debt maturity: the fall off in Bills as a percentage of total, coupled with an increase in Nominal coupons. Of course, just like in 2008, all we need to drop the effective duration of the portfolio is to create another market crisis where everyone rushes to the safety of Bills.

For those asking for a graphic representation of the historic and projected holdings of the Supplementary Financial Program, look no further. This is the latest gimmick in delaying hitting the debt ceiling in about a month.

The only saving grace, the amount of debt maturing in 36 months has dropped to the lowest in 20 years. The lack of a surge in debt roll requirements means the charade can continue a little longer.

We will spare you reading the thousands of pages in the just released budget: this is the only chart that matters. There is no surplus projected within 10 years. In fact, after a hockeystick pick up in the next 5 years, it drops off again. Not even uber-optimistic projections see any improvement!

And from the desperate we go to the surreal: the Treasury believes it can extract $2.4 trillion in Treasury demand from banks, pensions and insurers and Retail. Somehow we sense Jim Caron's involvement in this assumption. But wait, we thought everyone is migrating from bonds to stocks... How is this possible?

Yet the most interesting section in the presentation begins on page 54 of the attached pdf, where Tiny Tim discusses other options for debt management, where in addition to Century bonds already noted previously on Zero Hedge, the Treasury is also considering GDP-linked bonds: the same contraption used by pre-bankruptcy Argentina.

To wit:

  • Securities and Debt Management Techniques Discussed:
    • Ultra-long bonds and associated strips: 40yr, 50yr, 100yr
    • Bonds with embedded options
      • Callables
      • Puttables
    • Money Market instruments
    • Bonds for individual retail investors
    • Floating rate bonds
      • Short floaters
      • CMT-style
    • Other
      • GDP-linked bonds
      • A pure inflation security stripped from TIPS
    • Debt management techniques: interest rate derivatives, buybacks, mini-tenders, debt exchanges

Who said financial innovation is only created by JPM's CDS desk:

  • An Approach to Financial Innovation in the U.S. Treasury Market
    • Identify areas of excess net product demand and unfilled investor niches
    • Pricing analytics
    • Limit rollover risk
    • Lower interest cost volatility
    • Expand investor base
    • Liquidity
    • Distribution Methods
    • Time to develop market
    • Ease of accounting and taxation mechanics for the U.S. Treasury and investors

Here is what the Treasury determined regarding "Ultra-Long" bonds (read 100 years):

Ultra-Long Bonds: Main Conclusions

  • Demand. There is significant demand for high-quality, long-duration bonds from entities with long-duration liabilities such as insurance companies and pension funds.
  • Strips. The arithmetic of the maturity-duration relationship (duration rises much more slowly than maturity for ordinary coupon bonds) suggests that if ultra-long bonds are issued, they be made strippable (the duration of strips rises linearly with maturity).
  • Pricing. Dealers can determine where they see demand for the P-strip and then work backward to determine where to bid whole ultra-long coupon bond auctions.
  • Distribution. P-strip demand will give dealers a solid basis for bidding ultra-long coupon auctions. Syndication methods have been successful in other countries and could further support the distribution process but normal reverse Dutch auction process may also be sufficient.
  • Costs. Ultra-long bond yields are unlikely to be significantly higher than those in the 30yr sector, keeping issuing costs down. Spreads in the U.S. swap market and in overseas ultra-long bond markets are very tight to 30yr rates.

And for those for whom ridiculous duration is a must (not PIMCO), fear not - there is an app for that: 100 Year STRIPS:

Remember how the Treasury and Group of 30 was planning on squeezing money markets to get fund transfer into bonds? It's coming.

Regulatory Paradox:Regulations are creating a possible niche for increased bill and callable issuance targeting money market mutual funds

  • Money Market Mutual Funds (MMMFs)
    • SEC 2a-7 regulations requires the MMMFs to shorten the term of their assets by bringing the weighted asset maturity to 60 days from 90 days and to maintain 30% of their assets have to mature within 7 days.
    • This has increased the MMMFs demand for short-dated securities.
  • Banks and others
    • Basel III requires banks to lengthen their liabilities.
  • The gap
    • There may be room for increased bill and callable issuance to fill the emerging gap between MMMFs and issuers that will be created by new regulations.
    • This gap will naturally widen (MMMFs will want more short paper and banks and others will want to lengthen liabilities) if market participants expect that we are entering a rate hike cycle.
    • Puttable securities with puts exercisable every 60 days would find interest among MMMFs and offer a lower nominal initial interest rate for the U.S. Treasury.

And the kicker, on page 88 of 93: GDP-linked bonds. A/k/a the last recourse of any government facing insolvency:

GDP-Linked Bonds:Interesting but need more research to assess their potential

Premise:A GDP-linked bond pays a coupon based on a nation’s growth. For example, if trend growth is 3%, and a nation regularly borrows at 7%, a GDP-linked bond’s coupon will be 7% +/-the GDP deviation from trend growth (3% in this example).


  • Dampens the relationship between the business cycle and interest expense.
  • Reduces the pro-cyclicality of government spending by decreasing coupon payments in economic contractions, and vice-versa in economic expansions.
  • Allows investors to express a view on the economy’s future growth and may derive demand from equity index investors.


  • Complicated structure, difficult to price. Premium may be required due to volatility of cash flows.
  • Debate as to whether to adjust to the rate of growth of GDP, or the level of GDP.
  • Economic data, which is the basis of the reference rate, is frequently revised.
  • If GDP is strong, and coupons increase, investors may be concerned that the sovereign will “call” the bond or enact buybacks.
  • Demand for GDP-linked structures is unknown, extremely limited comparisons are available.

In other words: you know GDP-linkers are coming. And just in case they aren't, where are those who believe the Fed will be able to step away from monetizing the debt? We now know that there will be roughly $4.2 trillion in gross debt issuance in the next two years. Sorry, but there is no organic demand for this debt at any yields even remotely close to prevailing ones. And should interest rates go up, there goes the recovery.

Good night.

Full must read presentation (pdf)



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Mon, 02/14/2011 - 11:21 | Link to Comment Larry Darrell
Larry Darrell's picture

Second graphic......."Total public debt outstanding..."

Is that a Swiss Stair??

How long til you have to do these graphs in log form??


Mon, 02/14/2011 - 11:40 | Link to Comment AbandonShip
AbandonShip's picture

I don't know what it's called it but I saw a lot of similar worrisome charts in "This Time is Different" by Reinhart and Rogoff.   We're effing doomed  :(

Mon, 02/14/2011 - 11:27 | Link to Comment hedgeless_horseman
hedgeless_horseman's picture

...with all interest due to bondholders promptly remitted back to the Treasury...

Playing Monopoly with oneself is ok, I guess.  Just don't expect to fill up the car with gasoline using the Monopoly money.

Mon, 02/14/2011 - 12:12 | Link to Comment worldlymrb
worldlymrb's picture

It's not a Ponzi Scheme.  It's more like check kiting.

Mon, 02/14/2011 - 14:55 | Link to Comment Zero Govt
Zero Govt's picture

Timmays books look more bankrupt than Enrons and i thought he was such a nice clean prestine honest know-it-all putting the world to rights type of guy!!!

...shame on you Timmay

Mon, 02/14/2011 - 11:25 | Link to Comment RobotTrader
RobotTrader's picture

My prediction is that the stock run is nearly over.

Because TPTB will have to cause some type of a "financial convulsion" in order to get the speculative locusts to start fleeing back into bonds.

The Treasury selloff got out of hand, now the PigMen are already front-running the reversal.

Mon, 02/14/2011 - 11:28 | Link to Comment Turd Ferguson
Turd Ferguson's picture


Mon, 02/14/2011 - 11:40 | Link to Comment Greater Fool
Greater Fool's picture

Agree that something is coming. Retail flows out of bonds into stocks and the prevalence of stock-related headlines with "bubble" subtext are both increasing. Since I'm mostly long-term buy and hold, I'm less concerned with missing gains due to timing; just rotated the past 6 months of gains out of equities.

Enjoy the ride!

Mon, 02/14/2011 - 11:55 | Link to Comment Boston
Boston's picture

Exactly.  I went long T-Notes over the last week--50% of portfolio. 


Buying some popcorn and waiting for the scary sell-off to begin......

Mon, 02/14/2011 - 11:26 | Link to Comment DavosSherman
DavosSherman's picture


Mon, 02/14/2011 - 11:27 | Link to Comment stoverny
stoverny's picture

I'll take a 500-year bond, I'm on a calorie restricted diet and Kurzweil's actuarial escape velocity is coming any day now...

Mon, 02/14/2011 - 11:37 | Link to Comment ptoemmes
ptoemmes's picture

Speaking of (Raymond) Kurzweil...,8599,2048138,00.html

SkyNet and The Singularity.




Mon, 02/14/2011 - 14:33 | Link to Comment Da55id
Da55id's picture

Actually it's Gobel's actuarial escape velocity.

Wikipedia: "The concept was first publicly proposed by David Gobel, founder of the Methuselah Foundation.

The idea has been championed bybiogerontologist Aubrey de Grey[4] and futurist Ray Kurzweil.[5] 


Krill oil is nice :-)

Mon, 02/14/2011 - 11:29 | Link to Comment Turd Ferguson
Mon, 02/14/2011 - 11:29 | Link to Comment Stuck on Zero
Stuck on Zero's picture

The government needs your pension money!  The Feds will declare a pension crisis and save all of us by rolling over our failing IRAs and 401Ks into government bonds.  That's why they're running the stock market up right now. 

Mon, 02/14/2011 - 11:54 | Link to Comment jomama
jomama's picture

better fucking believe this is what's going to happen.

Mon, 02/14/2011 - 12:03 | Link to Comment earnyermoney
earnyermoney's picture

You realize this conversion will crush the equities markets?

Mon, 02/14/2011 - 13:42 | Link to Comment ElvisDog
ElvisDog's picture

That makes no sense. If they wanted to convert people's 401K's from stocks to government bonds, TPTB would want a stock market crash, not a ramp up. The idea would be to buy low taking advantage of fear. Who is going to want to convert from stocks to bonds when the stock market is advancing?

Mon, 02/14/2011 - 11:29 | Link to Comment bankrupt JPM bu...
bankrupt JPM buy silver's picture

Did I just hear a $400 bill cut THIS DECADE?  HAHAHAHAH, I hope I heard that right, silver through $30.50...nuff said, Blythe to rescue soon!


"US to live within its means"- right, like not buying iphones.  Reality TV continues...

Mon, 02/14/2011 - 11:34 | Link to Comment Huck T
Huck T's picture

I'll see your cord of firewood and raise you two chickens...



Mon, 02/14/2011 - 11:41 | Link to Comment Turd Ferguson
Turd Ferguson's picture

I see your chickens and raise a generator and a water purifier. Plus a side of beef.

Mon, 02/14/2011 - 12:11 | Link to Comment Snidley Whipsnae
Snidley Whipsnae's picture

"If GDP is strong, and coupons increase, investors may be concerned that the sovereign will “call” the bond or enact buybacks."

I will raise with my GDP linked bonds. ... before they are called or bought back by Tim...

401Ks, MMMFs ? sold that stuff long ago, paid the penalty and taxes and added to physical PMs... and, am way ahead of the game. Was a bit hairy at the time but it was the right move.

This damn gov is forcing us to do make hairy moves just to avoid financial wipe out.

Mon, 02/14/2011 - 12:17 | Link to Comment Huck T
Huck T's picture


Mon, 02/14/2011 - 11:41 | Link to Comment TideFighter
TideFighter's picture

GDP Bonds. Hardy-har-har-har. They haven't even considered:

Starship Enterprize Building Bonds

2nd Coming of Jesus Bonds

Donald Trump, Jr. (the XXVth) Development Bonds

Just Planted Redwood Tree Harvesting Bonds

Dissolved StyroFoam Bonds

Plutorium Unobtainium Mining Bonds

Red Pill/Blue Pill Bonds

I'm sure I missed a few.



Mon, 02/14/2011 - 11:57 | Link to Comment Rogerwilco
Rogerwilco's picture

"Donald Trump, Jr. (the XXVth) Development Bonds"

And nominate Ivanka Trump for President.

Mon, 02/14/2011 - 12:14 | Link to Comment Snidley Whipsnae
Snidley Whipsnae's picture

I am shorting Jesus bonds... He took a look at this mess and decided he wouldn't bother.

funny post, TideFighter

Mon, 02/14/2011 - 12:19 | Link to Comment snowball777
snowball777's picture

Red Giant Bonds

Mon, 02/14/2011 - 11:53 | Link to Comment Shameful
Shameful's picture

I'm impressed.  No really I am.  Look at the beauty and majesty of the indoctrination.  All of the evidence screams that bond investors will get pillaged and yet there are still buyers and holders.  It would be like a realtor selling a house that was on fire to a buying looking at it.

"It's a dream in the winter with all natural free heating and you won't have to pay for light either!"

A fool and his money are soon parted.

Mon, 02/14/2011 - 12:05 | Link to Comment Jason T
Jason T's picture

Bernankenstein!!!!! Stop the presses you lunatic!! 

Mon, 02/14/2011 - 12:13 | Link to Comment SilverRhino
SilverRhino's picture

So for GDP-linked bonds, if the economy is in recession does that mean the bondholder gets a freaking bill for negative growth?

Mon, 02/14/2011 - 12:26 | Link to Comment Snidley Whipsnae
Snidley Whipsnae's picture

Yes. And if the GDP goes positive, and you start making a few bucks, your bonds are called... Or the treasury will decide to roll your GDP linked bonds to 5,000 year bonds.

Mon, 02/14/2011 - 13:13 | Link to Comment Greater Fool
Greater Fool's picture

No. FRN's, for example, include zero-strike floors and a GDP-linker whose coupon resets off the rate would I'm sure do the same.

Either that, or you reset the notional based on GDP and pay fixed, the way inflation-linkers do. Then there may or may not be a principal protection provision on the bullet. (USD inflation-linkers have these, while GBP and JPY do not.)

You could argue, in fact, that the whole notion of GDP-linkers is pretty well redundant, given that inflation-linkers would be expected to have a lot of the same essential behaviors.

Mon, 02/14/2011 - 12:15 | Link to Comment topcallingtroll
topcallingtroll's picture

Everybody is looking fot a stock top. Even bulls are worried.

Mon, 02/14/2011 - 12:17 | Link to Comment Lighty
Lighty's picture

What strikes me is the hockey stick improvement in budget deficit from now to 2014, where a long-term 4% deficit is forecasted.I wonder which assumptions were used, but here is my take.

Considering the increment in debt from 2010 to 2020, they're forecasting an average 6,4% increase (=deficit). For Debt/GDP ratio to be 110% by 2020, this means GDP growth rate must be 4,3%.

Good luck achieving the two together.

2010 nominal GDP growth estimates are around 4,1 %; considering 1) 2009 was not a strong year and most importantly 2)a 14% deficit was run, how is it possible this growth rate can ever be sustained together with a shrinking deficit?

Looks like this question is not discussed.

Mon, 02/14/2011 - 12:21 | Link to Comment snowball777
snowball777's picture

We need more sheep!

Mon, 02/14/2011 - 13:07 | Link to Comment SDRII
SDRII's picture
  • Bonds for individual retail investors
  • 401K asset allocation mandate?

    Mon, 02/14/2011 - 13:29 | Link to Comment davepowers
    davepowers's picture

    thanks for posting and the analysis, Tyler

    Mon, 02/14/2011 - 14:50 | Link to Comment EB
    EB's picture

    One more thing to throw against the wall that was discussed in the minutes:

    The discussion turned to floating rate securities with short-dated reference rates such as bonds indexed to the 6-month T-bill rate with a semiannual reset. While such instruments would not protect Treasury against increased debt service costs in a rising rate environment, they would reduce rollover risks. CMT-style floaters, which have a reference rate that is generally on a maturity much longer than the reset period, have had mixed success in other countries due to the complexity of pricing.

    Mon, 02/14/2011 - 16:53 | Link to Comment dootyfree
    dootyfree's picture

    When will people learn the US cannot go bankrupt, the only threat is hyperinflation.  You must spend in order to tax.

    Mon, 02/14/2011 - 18:07 | Link to Comment SmittyinLA
    SmittyinLA's picture

    A better name than "GDP bonds" would be "mass immigration bonds".

    One sure way to grow the GDP is to grow the population (its not per capita GDP), and with the current global population of 6.x billion and US population at 300.x million and more than half the 6 billion would love to move to America and feed off the welfare state the possibilities for GDP growth are limitless.

    Do NOT follow this link or you will be banned from the site!