Author Topic: $27,000,000,000,000 US debt  (Read 4962 times)

LongHaul

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Re: $27,000,000,000,000 US debt
« Reply #30 on: September 14, 2020, 01:46:26 PM »
Thanks for the response Wabuffo and others.  I think the big deficit is more than one time and has been higher in the last 12 years than historically.

https://www.brookings.edu/policy2020/votervital/how-worried-should-you-be-about-the-federal-deficit-and-debt/#:~:text=For%20fiscal%20year%202019%2C%20which,GDP)%20in%20the%20previous%20year.

I have no idea what might make interest rates rise.  I really don't understand how they have been this low.
But I think it is very likely that they go up over the next decade to at least over the inflation rate.  Especially if you get a big country that defaults and scares the crap out of the
other democracies.  Historically financial panics came about when big banks or borrowers went under.

700 year low of interest rates.
https://www.visualcapitalist.com/700-year-decline-of-interest-rates/


Spekulatius

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Re: $27,000,000,000,000 US debt
« Reply #31 on: September 14, 2020, 06:35:11 PM »
Thanks for the response Wabuffo and others.  I think the big deficit is more than one time and has been higher in the last 12 years than historically.

https://www.brookings.edu/policy2020/votervital/how-worried-should-you-be-about-the-federal-deficit-and-debt/#:~:text=For%20fiscal%20year%202019%2C%20which,GDP)%20in%20the%20previous%20year.

I have no idea what might make interest rates rise.  I really don't understand how they have been this low.
But I think it is very likely that they go up over the next decade to at least over the inflation rate.  Especially if you get a big country that defaults and scares the crap out of the
other democracies.  Historically financial panics came about when big banks or borrowers went under.

700 year low of interest rates.
https://www.visualcapitalist.com/700-year-decline-of-interest-rates/

Interest rates were low in the 50’s and 60’s too, especially considering there economic growth. The spending from the Vietnam war was one factor increasing inflation and interest rates.

This is a Fiat System and it is build on trust. Once trust wanes, all bets are off. The Fed will lose control of the narrative, the USD May sell off, inflation will rise. Once the cat is out of the bag, it will be very difficult to get it back in. last time this happened we needed a Volker to ale some hard decision. We will see what happens next time.
Life is too short for cheap beer and wine.

scorpioncapital

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Re: $27,000,000,000,000 US debt
« Reply #32 on: September 15, 2020, 04:23:00 AM »
And how did Volker erase decades and years of mistrust? I mean in countries like Greece or Argentina you have serial default for their entire history, one after the other but far enough apart that old incidents are forgotten. I would say a short memory does more to clear distrust (temporarily) than any action by a harsh central banker. Even still you would expect average rates to be permanently higher the more such incidents exist.

wabuffo

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Re: $27,000,000,000,000 US debt
« Reply #33 on: September 15, 2020, 07:24:01 AM »
I have no idea what might make interest rates rise.  I really don't understand how they have been this low.

They are low because the rate paid on US Treasuries at issuance is at the discretion of the US Federal government.  It can be zero forever, if that's what the Treasury decides. 

That's because:
a) the US Treasury spends first, creating new reserves in the banking system's accounts at the Federal Reserve. (this creates new financial assets for private sector)
b) then the US Treasury comes in and removes these excess bank reserves via borrowing (conducts an asset swap with private sector for previously created financial assets). 

In true monetary and economic terms, its not really borrowing and using that word confuses everyone. US Treasury debt issuance is a hygiene activity for bank reserves - otherwise they would accumulate and drown the banking system.   TINA - there is no alternative.  In fact, the private sector prefers a Treasury asset over a bank reserve because bank reserves are illiquid and trapped at the Fed.  Treasuries are used as collateral because there is a shortage of credit-risk-free collateral around the world.  So even in a world of zero rates on bank reserves and zero rates across the entire yield curve, there would still be a preference for US Treasury debt due to its liquidity and safety as collateral.

The only real constraint is not borrowing capacity, then, because its not really borrowing.  The real constraint from deficit spending is currency debasement.  If there is enough currency debasement such that there is obvious inflation, then what will the Fed and US Treasury do?  That's the big question.  I don't have an answer - but the Fed is hinting that they will tolerate it and keep rates low for a long time to compensate for undershooting inflation in the past.  There do not appear to be any Volcker's at the Fed.  And I say all this while believing that the Fed is not as powerful as everyone believes (the real 800-lb gorilla of monetary policy is the US Treasury).

In addition to there being no Volckers (who I think is overrated frankly), I would add that there are no Greenspans either (who I think was the best Fed Chairman ever).  Despite the grief Greenspan gets, he always kept an eye on the gold price (as well as other commodities) and used it to guide Fed policy.  There's some quantitative proof for this.  Greenspan kept the USD more stable in price vs gold for longer than any other Chairman of the Fed.  To this day I'm convinced that Greenspan kept his target at $350/oz (10x the old gold price peg pre-Nixon closing the gold window in 1971).  The average price of gold during his long tenure averaged pretty much at this target price (with a +/- $50 band).   

1) Here's a table I once made up (and just updated for Powell) to show how Fed Chairman since 1971 have done vs the price of gold.   Greenspan shines.  (so does Yellen actually - though she wasn't there long enough to really tell).



2) Here's an academic study by George Selgin (I recommend reading his stuff if you are interested at all in central bank operations) that also hypothesizes that Greenspan followed gold in his rate decisions. [not sure if this link works - so I will attach a pdf of this academic paper as well]

https://www.semanticscholar.org/paper/The-Price-of-Gold-and-Monetary-Policy-Lastrapes-Selgin/c5d577dd46e898781bfeff704436a483b6ac72db?p2df

But I think it is very likely that they go up over the next decade to at least over the inflation rate.  Especially if you get a big country that defaults and scares the crap out of the other democracies.  Historically financial panics came about when big banks or borrowers went under.

Well every reserve currency default is different.  But it is interesting to examine how the UK lost its reserve currency status after World War I.  In its case, there were two reasons
1) it spent heavily to fund its war effort during World War I and eventually lost its military pre-eminence to a rising United States whose entry into WWI was the difference-maker in winning that war.
2) it borrowed heavily to buy supplies and armaments from the US to fight WWI - but its borrowings were largely in USD rather than GBP.  The UK also made a mistake trying to re-peg its currency to its pre-WWI gold price unleashing UK deflation.

So perhaps those are the two red flags for to watch for reserve currency loss:
a) getting eclipsed as the most powerful military in the world, and
b) and being forced to conduct sovereign borrowing in a currency that is not your own.

At present, there does not appear to be any clear and present danger to the United States' reserve currency status under either condition a) or b).   Finally, I would add another competitive advantage that the United States has.  Its geography:
https://worldview.stratfor.com/article/geopolitics-united-states-part-1-inevitable-empire

wabuffo
« Last Edit: September 15, 2020, 07:42:54 AM by wabuffo »

Munger_Disciple

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Re: $27,000,000,000,000 US debt
« Reply #34 on: September 15, 2020, 11:23:51 AM »
Quote
They are low because the rate paid on US Treasuries at issuance is at the discretion of the US Federal government.  It can be zero forever, if that's what the Treasury decides.

wabuffo,

By this do you mean that the Federal Reserve is a subsidiary of the US treasury? I thought the Fed set the interest rates (used to be ST only, now possibly the whole yield curve).

-MD

wabuffo

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Re: $27,000,000,000,000 US debt
« Reply #35 on: September 15, 2020, 01:47:20 PM »
By this do you mean that the Federal Reserve is a subsidiary of the US treasury?

Munger_Disciple - the first part of your question opens up a very interesting thread.  Who owns the Federal Reserve System?  Of course, the simple answer is that its conduct is regulated by Congress.  The Fed is a product of the 1913 Federal Reserve Act and the US Treasury is the arm of the Executive Branch that manages the public purse as per the laws passed by Congress (taxation, spending, debt limits, etc).

But what exactly is the ownership structure of the Fed?  In what ways is it independent of the US Treasury?  In what ways is it dependent on the US Treasury?

Many people mistakenly think that the Federal Reserve System is a private entity because chartered banks must purchase "shares" in their local Regional Federal Reserve Bank in order to become a Federal Reserve "member bank" and have access to the Federal Reserve.  Thus, the conclusion must be that the Federal Reserve System is owned by the chartered member banks and is therefore a quasi-private organization.  But there was a recent Federal Court Case (U.S. v Wells Fargo) that decided this issue.

https://law.justia.com/cases/federal/appellate-courts/ca2/18-1746/18-1746-2019-11-21.html

In this case, the Federal Court ruled that the "shares" in the regional F.R. banks owned by chartered banks are really debt contracts of the Regional F.R. Banks and that net profits of the Federal Reserve System all belong to the US Treasury (and not the chartered banks through their "shares").  So there you have it -- the US Treasury owns the equity of the Federal Reserve.  In addition, the settlement balances in checking accounts created for the benefit of chartered banks (i.e., bank reserves used for clearing payments in the Federal settlement system) that the Fed creates are also a product of the US Federal government even though they are "unappropriated dollars".  IOW - the chartered banks trade a private sector asset for a public sector asset (i.e, a bank reserve - which in turn is "an asset" of the Fed govt via the US Treasury).  So much for the idea that bank reserves can be "withdrawn" from the Fed to make loans....

Basically at the inception of the Federal Reserve, the US Treasury "purchased" a payments system infrastructure (a public good) and provided it to the central bank in exchange for an equity claim equal to 100% ownership (and retaining all "profits" the Fed makes).  The Fed thus becomes the US Treasury's subsidiary (ie, the US Treasury's bank) performing three important functions: a) running the US Treasury's general account for spending and taxing transfers to/from the private sector banks, b) running the national payment clearing system with the chartered banks that are members of the Federal Reserve System, and c) acting as custodian/transfer agent for the US Treasury's debt issuance by recording all transactions and ownership.

In an earlier post, I said the Federal government has three types of liabilities:
a) currency in circulation
b) bank reserves
c) US Treasury debt.

One can now see that, in effect, these are all, ultimately, liabilities of the US Treasury (some directly, some via the Fed).   Currency is minted (or printed) inside the US Treasury organization and delivered to the Fed when it issues an order to the US Treasury to provide it with currency (that's why the Secretary of the Treasury signs US banknotes and not the Chairman of the Fed).  We saw that the Federal Court basically ruled that even bank reserves created by the Fed are unappropriated "property" of the US Treasury/Federal Government.  And of course (c) is obviously an obligation of the US Treasury.

After its creation and throughout most of its history, the Fed built up its balance sheet by issuing currency to the private sector in exchange for Treasury bills/bonds.  Since the Fed ran a very asset-light balance sheet, the remainder of its balance sheet came from banks freely adding reserves to use the payments system by borrowing them from the Fed in exchange for collateral (more Treasury bills/bonds).  In fact, right up to the GFC crisis, this was the typical Federal Reserve balance sheet - dominated by holdings of US Treasury holdings on the asset side and banknotes (ie, currency in circulation) on the liability side, each accounting for 90% of the respective sides of the Fed balance sheet.

All in all - a long way of saying that the only way the Fed is independent is in how it sets the interest rate on reserves.  In all other ways, operationally as well as equity-wise it is dependent on the US Treasury and the US Federal Government and its accounts really should be looked at in consolidation with the US Treasury.  It is no more independent on most of its activities than the Post Office is.

wabuffo
« Last Edit: September 15, 2020, 02:30:12 PM by wabuffo »

Munger_Disciple

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Re: $27,000,000,000,000 US debt
« Reply #36 on: September 15, 2020, 09:20:46 PM »
Thanks wabuffo for such a lucid explanation of the interconnection between the treasury department and the fed. So it seems the only thing fed can do independently of the treasury dept is to set interest rate on bank reserves and treasuries and control what assets can the private sector can own. By purchasing MBS, treasuries, munis and corporate bonds, the fed is effectively taking them off the private sector hands, thus forcing the private sector into riskier assets to get any return.

Cigarbutt

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Re: $27,000,000,000,000 US debt
« Reply #37 on: October 04, 2020, 07:41:26 AM »
Thanks wabuffo for such a lucid explanation of the interconnection between the treasury department and the fed. So it seems the only thing fed can do independently of the treasury dept is to set interest rate on bank reserves and treasuries and control what assets can the private sector can own. By purchasing MBS, treasuries, munis and corporate bonds, the fed is effectively taking them off the private sector hands, thus forcing the private sector into riskier assets to get any return.
What you describe is the hot potato effect on a large scale. By actively suppressing interest rates that were already brought down by deep secular forces, the Fed’s only significant effect (apart from unintended consequences) is to swap the maturity profile of Treasury ‘debt’ issued (bonds, bills to fiat) and the effect of the maturity profile recycling has been, through asset price inflation, to bring all forward returns closer to zero (cash) or closer to what the Fed is paying on excess reserves. This is why an argument can be made today that to-be realized returns from growth stocks like Apple, from old-economy stocks like oil-related and financials, from razor-thin spread corporate bonds and from government bonds to bills have been compressed to a very narrow band.
-----
Active suppression of interest rates (ie as the last example of this secular trend: the Fed absorbed most of the debt issued so far peri-Covid) has made it easier to issue debt (this point should not be controversial). Is this a good thing or is this the ideal choice?
Some perspective from previous CBO ‘forecasts’:



So, the Treasury has taken advantage of the fact that interest rates on its debt (which is almost yield-curve-controlled at this point) has remained low and in fact gone towards zero (and more?). Retrospectively thinking in terms of alternatives has limited usefulness because of very obvious limitations (cannot change one variable without considering second-order or domino effects), but it is obvious that the Treasury could not effectively ‘function’ now if they had been right on their forecasts of the direction of interest rates (they just followed the consensus and conventional view that growth would revert back to historical levels and more and that this would steepen the yield curve; but growth has not bounced back to historical trends (to the contrary) and the curve is ‘steep’ but the 30-yr rate is at 1.49% (!) at the time of this writing (who thought this would be possible just a few months ago?)).

Just for fun though, let’s see the result of this impossible scenario (what CBO predicted during this last 'recovery' in terms of rates with everything else unchanged).
-Typical historical range of net interest payments on debt as % of federal outlays: 7-15%   now: about 9%
-Typical historical range of interest (in fed outlays) as % GDP: 1.2-3.1%   now: about 1.75%
-Average interest rate on US gov. marketable debt securities: 2000: 6.41%   2007: 4.93%   now: 1.66% (!)

So assuming 2007 to 2000 avg rates apply now, this would mean:
-net int. as % of outlays: 27-35% (!)
-interest as % of GDP: 5.2-6.8% (!)

Obviously this could not have happened without something (structural reform, focus on productive growth) but the message is that this easing has put the US on a path that looks like a debt trap (Canada and others look the same). There is hope to get out of this pattern by spontaneous reversion to the mean and to grow out of it but it seems that this is ‘easy’ (or even MMT-like) magical thinking that is over and above what typical animal spirits could accomplish under present circumstances. This set up of easing rates looks more and more like a liquidity trap self-fulfilling prophecy.

wabuffo

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Re: $27,000,000,000,000 US debt
« Reply #38 on: October 04, 2020, 08:24:38 AM »
Active suppression of interest rates (ie as the last example of this secular trend: the Fed absorbed most of the debt issued so far peri-Covid) has made it easier to issue debt (this point should not be controversial). Is this a good thing or is this the ideal choice?

I think its controversial because I believe its wrong.  What if the conventional wisdom has the causation totally backwards?   

What if the reality is that the US Treasury issues debt to help out the Fed, (instead of the Fed buying Treasury debt to help the US Treasury "borrow")? 

wabuffo
« Last Edit: October 04, 2020, 08:35:04 AM by wabuffo »

Cigarbutt

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Re: $27,000,000,000,000 US debt
« Reply #39 on: October 04, 2020, 10:05:55 AM »
^i'd say this thread is unlikely to get traction if we start to argue about the mechanics of the Treasury Account at the Fed. :)
Your perspective, as always, is thought-provoking.

Your perspective seems to include that the Treasury is in the driver's seat (which i agree with), so what is the Treasury trying to achieve here? To help the Fed?
During and around the Great Depression and WW2 (extreme example but valid and maybe we're in a war, an unusual war in which we don't see (or don't want to see) the enemy), the Treasury needed to expand and to pay for unplanned expenditures so they entered into an agreement with the Fed to keep rates low. So, was the Treasury into government-sponsored social- and war-related expenditures or into Fed's reserves-management help?
A major objection to the Fed help point of view is that the Treasury took advantage of a flight-to-safety mood at whatever level of interest rates to issue debt enough to increase reserves (through central bank purchases as a side effect) AND to raise the Treasury Account (in cash or printed money) to unusually high levels. This cash reflects the planned expenditures (have you read the Cares Act and what it means for federal outlays going forward?), will eventually enter the system but is meant essentially to match the output gap and some of that will become reserves as part of the Fed's plan to keep rates low for as far as the eye can see. If the Treasury's intent was to help the Fed, why would it issue debt to the extent that a lot of it ended up parked at the Fed?
Let's say you're the CFO of a bankrupt airline in an emerging country and the IATA, somehow, becomes in charge of the terms of DIP financing and decides to keep the terms very loose. Isn't it possible then that the distressed airline would 'secure' too much debt for its ultimate productive capacity? The market 'works' because it does (when it's allowed to). Or would the airline's goal be to help IATA in search of reserves?