This page has been archived and commenting is disabled.
What's More Important: Debt to GDP or Supply?
There may be a flaw in the thinking our economists, financial leaders,
the MSM and (even) the bloggers. Everyone is looking at the debt issue
based on some ratio of total debt to GDP or debt service to GDP. This is
the way it has always been done and is both right and appropriate. How
much debt can be afforded is a ratio of the borrowers income whether it
is an individual, a company, a State or a Sovereign. But there is (to
me) evidence of a new metric developing. Supply is quickly becoming the
determinant for the cost of borrowing, not debt to GDP levels.
Consider California. They have a monster GDP. Their debt to GDP is one
of the best in the country. They have debt equal to only 6% of GDP.
Massachusetts and Rhode Island are north of 20%.
But California is the official junk borrower. They just paid 5.8% for
ten-year money. On a taxable equivalent yield that comes to 9%. Cali's
CDS spreads are also in the tank. Their spreads are trading even up to
Bulgaria. It is not their GDP that is the problem it is their visible
supply of paper.
The inversion of the ten-year swap spread is completely crazy. It is
almost impossible to think that this could happen. But it has. This is
all about supply folks. $200b a month of new IOUs is the issue. The Debt
to GDP ratio for the US is a disgrace. It is still favorable to most
other sovereigns. But we’re now trading to a AA. We pay more for term
debt than many other nations.
The US has $8+T in federal paper outstanding to the public. That will
increase by 50% or more in the next five years. The Agency paper in
public hands is an additional rollover problem. It is likely that
Social Security will be a net seller during this period. They once
funded 50% of our deficits.
Will someone please tell me who is going to take this on? Consider the
list of existing big holders. I will give you an argument against any of
them solving this supply problem. Please don't tell me that US
households are going to pony up for this. And don’t tell me that I
shouldn't worry about supply because Ben B. will buy whatever is
necessary. We would be destroyed in less than three years if he did
that. And he knows it.
At every step of the way over the past twenty-four months the “markets”
have forced the policy makers hands. From Bear to Lehman, to AIG, TARP,
ZIRP, QE, Bizzaro Budgets, Clunkers, HAMP and all the rest. The
objective was always to blunt the markets. The Stock, Treasury bond,
Real Estate, Corporate bond, MBS, ST/LT interest rates, currency, swaps
and derivatives markets have all been manipulated for some time now. The
question is, “who has been manipulating whom?” More important is, “who
is winning?”
At this point I see that the ‘markets’ have successfully forced the
global policy makers to absorb the absolute giant share of the credit
losses of the bubble. A monumental cost will come from the D.C. lenders.
They are hobbled with bad debts, while the remaining private financials
have earned a bundle on the ZIRP. The market has forced the
socialization of total debt/bad debt to a point where the remaining nut
is manageable.
With the end of QE the cycle is now complete. The maximum amount
of risk in the form of credit exposure and aggregate debt has now been
passed to the public sectors around the world. As markets are wont to
do, they are likely to turn on their benefactors now that they have
succeeded. If total supply and visible supply are going to
become more powerful forces than traditional metrics of determining debt
pricing, it will have to end up at America’s doorstep. We are the
‘category killer’ when it comes to supply.
»
- advertisements -
If supply/demand (take your pick) becomes an issue, rates will rise to clear the market. It has always been thusly. I started trading bonds in 1980 and short rates were in the teens.
Maybe rates go there again, but we were able to function then (just barely.) I assume we'll continue to keep functioning if it happens again.
debt . .. the important ingredient is capital .. saved earned investment ,
the idea that debt to any ratio when governments play the part. is a path to disaster ,
the Keynesian's among us,, can not get this in their brains .
debt is the road to no-where .
the debt parade is a race to the bottom.
Bruce. I thought you were going the right direction until you got to supply. The Fed doesn't have to offer any long term Treasuries. It can just stop issuing the 10 year altogether. All it has to do is calibrate the supply of the maturities to market demands. If the Fed wants to keep their funds in cash accounts, fine, then they can choose not to take in a higher yielding instrument. If treasury issues longer maturity debt into a market that does not want more, yields rise at the long end and increase government interest spending, which will increase budget deficits and thus debt ratios. This might be worth investigating as it would suggest that government should try to shorten the maturity structure when the market doesn’t want longer maturities. It certainly does look like the decision to begin to issue 30 year debt again (in early 2006) might have been a mistake because in recent months issues of longer term debt have been met by stubbornly high yields. It is conceivable that the market for long term debt is saturated.
I think Bruce makes a good point. The points made about demand are also valid. Ultimately, I think the Fed (or PPT, or any other market manipulator) will allow a dramatic fall in the stock market. In fact, stock markets around the globe will probably get killed too. This would cause a massive global flight to ""safety"" that would allow our government to simultaneously issue longer-term paper and print more money. If there was a global flight into US Treasuries, it would most likely be into longer dated ones. In addition to downward pressure on rates at the long end of the curve, this would also lead to huge dollar strength. The Fed would then be allowed to print money to offset the strength of our currency.
There has been some mentioning here at Zero Hedge regarding the correlation of the Nikkei 225 (on a 10 year advance) and the S&P 500. I strongly believe this correlation will hold for many years to come. If it does, it means May will begin the largest stock market correction in US history since the Great Depression. (far eclipsing the decline of 2008 and 2000)
I think a massive global equity selloff is the only thing that will allow the US to issue and roll the paper they need to. Substantially higher rates are just not an option. (too much of a hit to GDP)
Who knows, maybe that is why the markets have been lead higher and higher all this time. The bigger they are, the harder they fall.
P. Profit
There has been much discussion on this Treasury flight to safety. However, in many ways for investments now in US equities, the flight to Treasuries, constitutes money that is neither nimble or smart.
Let me explain.
1) The question is who is fleeing to safety?
Perhaps at some point only the slowest and unconcerned mutual funds when they reach a breaking point. That is unconcerned for their 401(K) investors. The last fall in equities, had many stock mutual fund managers spewing the corporate line as values drop 40%, while still insisting to ride it out.
2) The smart money is going to exit quickly and except for a short term park, not accept the ultra low interest return for short term US Treasuries.
3) Who would invest in Treasuries beyond 2 years. Only the uninformed.
4) It is much more likely, this time around, to see movement towards currencies or other equity markets outside of the US. Perhaps even commodities and other hard assets within the US, but not equity or gov/state debt.
5) Most of the smart money is already out of US equities, holding something else of tangible value.
US Government debt is not safe anymore relative to the return. The USD is probably only a short term play at maintaining real worth.
----------
If you are proposing a severe sell off in US equites, I see the collateral damage manifesting itself in different ways.
1) Huge systemic risk possibilities for the BHCs. Losses and write offs will increase. The Treasury will have to extend TARP indefinately.
2) A massive contraction in equities based wealth will effect private spending. We will import less goods, turning foreign buyers away from Treasuries.
3) Without the returns possible from equities the ability to deleverage debt will decrease. Leaving even less money for new investment.
As you can probably see, that what I am describing is the beginning of a deflationary spiral. So, at this time, the only "economic" strength for the FED and Administration is equities. If you remove this preservation of price and wealth, which they have spent Trillions of tax payer dollars, the FED and Washington will not have many more cards to play. The application of more stimulus will just increase the rate at which we sell debt.
I guess my real concern is that capital investment will flee before we reach a crisis. The smart money will not be around to see a collapse of investment returns and principle.
Mark Beck
On a cash flow basis to me, it is what is important are expenditures and revenue. Debt is a function of deficits. Debt in relation to GDP, as measured by the US, is not necessarily an indicator of a countries ability to pay debts or in its prerogative to address deficits.
I often ask myself, why does a diversified state like California, with its large population, need to sell debt? Fundementally, there is something very wrong with how the state is governed. But, I think more importantly, it has really lost its sovereignty to the Federal government in terms of controlling costs. Put simply the states can no longer afford Washington.
Bruce, I like how you discussed the issuance of debt. Especially in some of collateral effects. Which I would describe as inefficiencies of government malinvestment. But, more importantly from a macro economic standpoint, what is the worlds capacity for purchasing debt?
My first gut response is, interest on the 10Y, or the rate of spread divergence. But, this is perhaps just an effect and not a way to properly identify buyers of debt in a de-leveraging world. My point is, that the prolonged lack of buyers will, at some point, produce an exponential effect in rates if the central bank does not intervene. This intervention cannot be prolonged without the eventual destruction of the currency. More importantly to me, is the fact that the FED and administration will have to openly admit that it is policy that the FED continually buy our own debt to pay for the administrations deficits. This clearly is not why the FED was created, and by way of action, puts in jepordy both the current Administration and the FED chairman.
Mark Beck
Cali's debt to GDP is only 6%, but they have to pay higher yields because
a) They don't get 1st dibs at their resident's paychecks - the Feds do.
b) AFAIK, Cali's own gov't can't tax their residents without residents' own consent ;)
freely
p.s. if USA can eliminate dependence on foreign hydrocarbons, what if USA simply defaults?
I think the the increase in supply, in conjunction with risk of decreased demand, is the issue. Or at least the one that could make things change very quickly.
As I noted the other day on the thread about CLOs, the CLO market plumetted in 2007. This was not due to underlying credit issues (those happened later), but because demand suddenly fell off a cliff.
When the mortgage crisis began, the global investors in CLOs (insurance companies, banks, hedge funds, plus some pensions and HNW) suddenly pulled back, due to losses in their mortgage positions.
This made the spread required to clear the market skyrocket in a period of weeks.
Imagine if that demand for UST suddenly dried up (whether due to concerns over US credit or to sudden losses in the investors other positions reducing cash available). UST rate would have to increase to attract what capital there were.
If UST supply were low, this might just be a nuisance. But when supply is high (due to rising deficits and rollover of short tenor UST paper), it could be a major problem and hit very suddenly.
Of course, the UST would fare better than an illiquid instrument like a CLO, and would fare better due to US as a credit haven (assuming the underlying cause of reduced demand were not over credit concerns about US), but the issue is still the same.
In addition to the liquidity difference, the sellers of USTs can also be the buyer (QE) and can also do things to affect demand (e.g. kill risk and drive flight to quality). Very different and very rigged. Imagine the possibilities when you can so greatly influence both supply and demand!
We apologize for any inconvenience and we invite you to check back shortly. For any information or Online orders please contact us at 1-877-775-4826. Thank you for your understanding.b I haven't been able to get this site for hours...
Just logged on. The site looks OK now.
When this whole debt-based economic, financial and monetary system finally implodes --- and it will --- I will revel in 100,000 "I told you so!"s. And the statist psychopaths like Geithner, Bernanke, et al will still be in the fray, peddling their corrupt oligarchic "solutions" to the catastrophe that they directly created.
TSHTF a while ago and people are still arguing about issues that pertained to the previous order of things.
Get your shit in one sock in a hurry because life is gonna be different next year.
If I am wrong, I'll be very happy. If I am right, you better be prepared...
demand is only an issue for the news makers. mkts have 3 trillion in coupon income coming to mkts in 2010....
Bruce,
Please expand on this:
"And don’t tell me that I shouldn't worry about supply because Ben B. will buy whatever is necessary. We would be destroyed in less than three years if he did that. And he knows it."
In theory, QE can go on as long as the Fed wants to engage in this activity. Also, apart from agency paper, those debts states report are not taking into account their pension deficits. If governments can't tax people to make up for shortfall, or raise contributions because they're scared of union reprisals, they'll just issue more debt. Record debt issuance will send yields higher.
The FED's QE is creating "high power money" in the monetary base to offset the destruction of M3. As long as deleveraging remains in play and velocity stays low this should not create inflation or by itself destroy us in 3 years.
But any resumption of leveraging or increase in velocity or expectations of the same could cause things to get funky fast. BB saying he has to get the FED's balance sheet back under $1T is imperative, but it is also imperative that he put actions behind his words and it is equally imperative that participants believe he will do what he says. Losing control is what could destroy us.
True... And there is no way in hell that this money will make it into the real economy even if economic growth magically begins to take hold. This QE is insurance and will only enter the real economy once deleveraging and defaults have destroyed M3 supply. Call me a paper bug but I believe the dollar will be around long after we're gone...
"Losing control is what could destroy us."
Who is 'us'. I thougt 'us' the taxpayer had already been destroyed. Please enlighten us.
It is the same as Bruce's "we"
Seems to me you have it backwards too, Bruce. The problem is not supply, there is plenty of that. The problem is demand. And that is going off a cliff.
I think Bruce is correct. The slack in the world economy is trashing tax revenues, while Keynesian economic policies have lead to massive increases in expenditures. Japan bled its own people for 20 years to support its deficits, but the US citizens don't have the savings necessary to bail out Uncle Sam. The large entitlements are hanging like cinder blocks around our necks, and we will reach a point when we either cut the rope or go under and drown. Logically, that assumes there will be massive overhauls to Medicare, Medicaid and Social Security.
China is no longer willing (and perhaps not able) to continue subsidizing our deficits. Europe is in worse shape than we are, so who can take up the slack? There will become a point when monetizing (printing money to buy back our own treasuries) becomes the only option, and what then? The cost of borrowing will go up regardless of ZIRP, and Zimbabwe Ben or his successor will have the choice to debase the dollar or default.
but the US citizens don't have the savings necessary to bail out Uncle Sam.
If the gubmint decides to exchange our IRA holdings into Treasury notes and bonds, they may have the the savings necessary to bail out Uncle.
So. US citizens don't have the savings necessary, China is no longer will to subsidize us, and monetizing will be the only option.
All examples of lack of demand for US debt; none of those statements has anything to do with supply. After all, don't all good Keynesians believe that it is the demand side (aggregate demand) that is the problem, everywhere and always?
Wait - do you mean there are some Austrians out there?
There is a macroeconomic lack of supply (available capital) to continue funding steepening deficits which will result in a worldwide money printing spree which will work for a while, until it doesn't.
I think that it is both. Bruce explicitly mentions increased supply, but he cites many instances of reduced demand - social security becoming a net seller of its special Treasury paper, US households not buying Treasuries.....he didn't mention that the Japanese are starting to spend their personal savings and sooner or later tht will result in Japan dumping Treasuries.
Kinda of confused here Bruce, are you talking about supply of paper money, or supply of goods and services?
I thought he meant production,jobs,income to sustain the flow
Sorry, using street lingo. In this case visable supply means the amount of money that must be borrowed in an identifiable time period. A week, a month, a year, a decade.
I am sure he is talking about supply of debt paper - not to be confused with freshly printed money. California is paying through the nose - not because it is a dicey borrower (which I think it is despite Bruce's rtather constructive arguments), - but because they are being underbid by all of the other entities grovelling for dollars to feed their deficits.
If I may, I believe it is supply of paper debt.