September 28, 2010
Money Is Still Money, Isn't It?
The emphasis on America's national debt doesn't tell the entire story. Federal finance is rather different from that done by the individual. The debt payments an individual makes on his house ultimately result in retirement of his debt. The individual then owns his house outright; he's paid off his debt. That's because his monthly payments went to both interest and principal, or debt service.
But the line item in the federal budget for the national debt isn't for debt service; it's just for interest. By the time a treasury bond matures, all that's been paid is interest.
And where does the money come from to pay back the principal? Much of it comes from refinancing: In what we'll call "rollover," the feds sell new treasuries to raise the money to pay back the principal on old treasuries. That's why an exactly balanced budget, where income equals outgo, will never pay down the debt. Were Congress to exactly balance the budget from now on, the national debt would freeze at $13.4 trillion, and we'd never get out of debt. We'd be paying interest for eternity on the same loans. ("Rollovers" of national debt are probably the most successful of chain letters.)
The federal government has depended on an unending supply of willing buyers of their financial instruments. But if we wanted to retire debt so that the feds wouldn't have to "roll over" treasuries for the rest of history, Congress could run a budget surplus dedicated to paying down the debt. How fast we retired debt would depend on the size of that surplus. A surplus of $100B a year retires $1 trillion in a decade. Retiring the entire national debt at that pace would take 134 years. For the "debt held by the public," it would take about 89 years.
There are two reasons why the "rollover" of federal debt is dangerous. The first reason is that America will be held hostage to whatever the prevailing interest rates are at the time of "rollover." In The Wall Street Journal on September 10, Jason Trennert reports:
You've probably heard that the federal government is facing budget deficits that are larger as a percentage of GDP than at any time since World War II. But did you know that Uncle Sam is using capricious short-term funding to satisfy its long-term liabilities?
One wonders how Treasury Secretary Timothy Geithner can sleep soundly at night with the knowledge that more than 60% of America's sovereign debt is set to mature within the next three years. To be precise, $5.2 trillion of U.S debt comes due in the next three years out of $8.3 trillion outstanding.
The Treasury Department responded with a letter to the editor: "His statement that debt maturing over the next three years exceeds 60% is incorrect. The actual figure currently stands at 55% and is declining."
Whether 60% or 55%, those treasuries will "roll over" at whatever the going interest rates are. And if the economy picks up, those rates will be higher, as U.S. interest rates must be competitive if the world is to buy our debt.
The second reason why "rollover" should be of concern is the possibility that we won't be able to find buyers for our debt. The status of the U.S. dollar as the world's reserve currency has come into question lately. China and Japan may no longer want to invest in our treasuries. But a balanced budget would restore confidence in the U.S. dollar by showing the world that America is once again a serious nation.
Like our total federal debt, our long-term liabilities also boggle the mind. We cannot grasp these huge numbers. But the only number we can really do anything about is the yearly number, the deficit, which is a function of the yearly budget.
Like all else, bankruptcy happens in real time -- what we used to call "the present." So if America were to default, it would be because she can't meet her current obligations, not her future ones. Of course, some will say that America will never default on her debt, because unlike Greece, the Federal Reserve can create money ex nihilo, out of nothing. The poor Greeks, however, are tied to the euro. If they were still on the drachma, they could create money and postpone their day of reckoning, just like America. But of what value is being technically solvent if the currency has lost its value?
If no one steps up to buy our debt, the Fed will throw the proverbial printing presses into high gear and create money. The good news is that the Fed would be retiring debt, not rolling it over. The bad news is that paying back principal with newly created money comes at a terrible price -- inflation.
Imagine the inflation unleashed were the Fed to monetize the $5.2 trillion of soon-to-mature treasuries that Trennert worries about. America has little experience with hyperinflation. We're not familiar with the kind of insane inflation that destroyed the German mark in the 1920s, when their currency was so devoid of value that Germans burnt Papiermarks to heat their homes.
In America, the "smart money" may soon be moving out of money -- at least American money. This reminds us of the scene in Schindler's List in which a Jewish investor argues with Schindler over his lousy terms:
Investor: Money's still money.Schindler: No, it is not. ...Things have changed, my friend.
Jon N. Hall is a programmer/analyst from Kansas City.