In Part 1 of "U.S. Government Debt - The Ultimate Subprime Loan," we covered the various factors that lead us to believe why the government debt of the United States could potentially be much worse than the subprime loan problem. In this article, we will address the question of, "Who will finance this massive debt?"
As estimated in Part 1, we believe that we will have to finance approximately $4.4 trillion in 2010, $2.034 trillion in 2011, $939 billion in 2012, and well over $1 trillion per year thereafter, in a combination of refinancing upcoming U.S. Treasury security maturities and new financing of estimated budget deficits. That is a lot of debt to finance at a time when the strength of the dollar and American economic dominance are being questioned.
If we are to finance this debt rather than raise taxes and/or devalue (inflate) the dollar, then we can either finance our debt internally or we can look to foreign investment. We will first look to our foreign neighbors who have financed a large part of our debt thus far.
According to the U.S. Treasury, foreign investments in U.S. Treasury securities increased from $3.0 trillion to $3.6 trillion between November 2008 and November 2009. That is an increase of roughly $600 billion. The largest holders of our government debt are China and Japan. During that time period, China's holdings increased $77 billion (from $713 billion to $790 billion). Japan's holdings increased $132 billion (from $625 billion to $757 billion). Other top holders including U.K., Oil Exporters, Caribbean Banking Centers, Brazil, Hong Kong, and Russia collectively increased holdings by $237 billion (from $839 billion to $1.076 trillion).
According to the U.S. Census Bureau, we have been running an average savings rate of 2-3% here in the U.S. over the past decade. This rate increased in the past six months to 4-5% in response to the economic crisis. These savings rates were on disposable incomes that have averaged around $10 trillion over the past few years. These savings can find their way into U.S. Treasury securities through various conduits such as mutual funds, insurance companies and other financial institutions.
Now we will make some generous assumptions for those who have doubts about our perspective. If we assume that foreigners continue to be willing and able to finance our debt at current levels, then they should be able to absorb approximately $600 billion per year. And assuming that U.S. citizens continue to keep savings rates elevated at 5% on roughly $10 trillion of disposable income, we should be able to absorb an additional $500 billion. We consider these assumptions to be generous because other countries are facing similar challenges to ours and there is no guarantee that disposable incomes and savings rates can remain elevated here in our difficult domestic economy.
This leaves us approximately $2.9 trillion short in 2010 and $900 billion short in 2011. This means that the Federal Reserve (the lender of last resort) will likely need to step in and purchase almost $4 trillion of U.S. Treasury securities over the next two years and monetize the debt. Those who understand the fractional reserve banking process will quickly recognize the inherent danger of such actions. The Federal Reserve has already doubled the size of its balance sheet over the past year to over $2 trillion. Our current problem could easily more than double it again from current levels.
Of course, these are generalizations and the mechanics could certainly work out differently. For example, the Federal Reserve has been buying more mortgage securities lately, which provides foreign holders and financial institutions liquidity to soak up the new U.S. Treasury securities (this is effectively swapping mortgage debt for government debt). The velocity of money could remain low for an extended period, which could reduce the threat of inflation. However, a further decline in global economics could lead to another wave of risk reductions, which could widen interest rate spreads again and move money from corporate and other debt into government debt. With all of the "what-ifs," we believe our overall point is made clearly.
Another potential problem could come from an increase in interest rates. Increased rates could come simply as a function of supply and demand forces. They could also come in the form of a risk premium required by investors who may question dollar-denominated assets. A rise in interest rates would place additional pressure on our budget deficit and could require further debt issuance.
No matter what happens, we always come back to the most fundamental economic principle: supply and demand. And we believe there is simply too much coming supply of U.S. Government debt for the amount of demand. In our next article, we will discuss what we can do to protect ourselves from the potential fallout from this problem.
Part 1 of this series and more can be found at our website IgnoreTheMarket.com.
As estimated in Part 1, we believe that we will have to finance approximately $4.4 trillion in 2010, $2.034 trillion in 2011, $939 billion in 2012, and well over $1 trillion per year thereafter, in a combination of refinancing upcoming U.S. Treasury security maturities and new financing of estimated budget deficits. That is a lot of debt to finance at a time when the strength of the dollar and American economic dominance are being questioned.
If we are to finance this debt rather than raise taxes and/or devalue (inflate) the dollar, then we can either finance our debt internally or we can look to foreign investment. We will first look to our foreign neighbors who have financed a large part of our debt thus far.
According to the U.S. Treasury, foreign investments in U.S. Treasury securities increased from $3.0 trillion to $3.6 trillion between November 2008 and November 2009. That is an increase of roughly $600 billion. The largest holders of our government debt are China and Japan. During that time period, China's holdings increased $77 billion (from $713 billion to $790 billion). Japan's holdings increased $132 billion (from $625 billion to $757 billion). Other top holders including U.K., Oil Exporters, Caribbean Banking Centers, Brazil, Hong Kong, and Russia collectively increased holdings by $237 billion (from $839 billion to $1.076 trillion).
According to the U.S. Census Bureau, we have been running an average savings rate of 2-3% here in the U.S. over the past decade. This rate increased in the past six months to 4-5% in response to the economic crisis. These savings rates were on disposable incomes that have averaged around $10 trillion over the past few years. These savings can find their way into U.S. Treasury securities through various conduits such as mutual funds, insurance companies and other financial institutions.
Now we will make some generous assumptions for those who have doubts about our perspective. If we assume that foreigners continue to be willing and able to finance our debt at current levels, then they should be able to absorb approximately $600 billion per year. And assuming that U.S. citizens continue to keep savings rates elevated at 5% on roughly $10 trillion of disposable income, we should be able to absorb an additional $500 billion. We consider these assumptions to be generous because other countries are facing similar challenges to ours and there is no guarantee that disposable incomes and savings rates can remain elevated here in our difficult domestic economy.
This leaves us approximately $2.9 trillion short in 2010 and $900 billion short in 2011. This means that the Federal Reserve (the lender of last resort) will likely need to step in and purchase almost $4 trillion of U.S. Treasury securities over the next two years and monetize the debt. Those who understand the fractional reserve banking process will quickly recognize the inherent danger of such actions. The Federal Reserve has already doubled the size of its balance sheet over the past year to over $2 trillion. Our current problem could easily more than double it again from current levels.
Of course, these are generalizations and the mechanics could certainly work out differently. For example, the Federal Reserve has been buying more mortgage securities lately, which provides foreign holders and financial institutions liquidity to soak up the new U.S. Treasury securities (this is effectively swapping mortgage debt for government debt). The velocity of money could remain low for an extended period, which could reduce the threat of inflation. However, a further decline in global economics could lead to another wave of risk reductions, which could widen interest rate spreads again and move money from corporate and other debt into government debt. With all of the "what-ifs," we believe our overall point is made clearly.
Another potential problem could come from an increase in interest rates. Increased rates could come simply as a function of supply and demand forces. They could also come in the form of a risk premium required by investors who may question dollar-denominated assets. A rise in interest rates would place additional pressure on our budget deficit and could require further debt issuance.
No matter what happens, we always come back to the most fundamental economic principle: supply and demand. And we believe there is simply too much coming supply of U.S. Government debt for the amount of demand. In our next article, we will discuss what we can do to protect ourselves from the potential fallout from this problem.
Part 1 of this series and more can be found at our website IgnoreTheMarket.com.
