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Bonds Away . . .Ka-Boom!

June 29, 2014

“I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
- -James Carville, Democratic Strategist

Fantasizing intimidation is one thing, but in the end, reality always trumps dreams. In the case of the bond market, this ‘intimidation’ James Carville is musing over is about to give way to something a bit more serious . . . reality.

Bonds are I.O.U.s. In order to pays its bills, the U.S. and many countries issue I.O.U.s called bonds. Some of the I.O.U.’s are for one year, others for 10, 20, or 30 years. In today’s world, borrowing is a way of life. How much a country borrows can be telling though. Is the country living within its means; the amount of debt easily manageable if hard times were to arrive? Will the debt be used for productive purposes? For example, building dams, producing electricity at reasonable rates can be a productive use of debt, versus debt for war, interest payments on the liability itself, or social welfare programs.

Calvin Coolidge, our 30th president understood debt: “There is no dignity quite so impressive, and no independence quite so important, as living within your means.”

So, how does the U.S. stack up relative to other nations when it comes to borrowing money? Or, in Coolidge’s words: measure-up in ‘independence’ and ‘dignity?’ The U.S.’s debt is a staggering 17.5 trillion dollars, garnering the distinct honor of being the world’s largest debtor nation, with Britain in second place at 10 trillion. Singapore, on the other hand, has no financial liabilities – no I.O.U’s. They spend only what they generate in taxes.

A trillion is difficult for the mind to grasp, the amount defies imagination. For example, a trillion seconds will bring one back 30 thousand years before the Roman Empire. A trillion days takes us back before the universe began.

The evening news will often bandy about enormous figures: millions, billions, trillions when focusing on the budget. They are numbers: numbers we have become numb to. Nightly news over, the dollar amounts disappear from memory, time for one’s favorite show.

Can this titanic debt continue indefinitely? In the Road Runner cartoon series, Wile E. Coyote is seen darting about at breakneck speed chasing after a bird, giving little thought to anything other than catching the fowl. In his mad dash, Wile ends up running off the side of a cliff. Of course, there isn’t any firm ground beneath. In mid-air, Wile scrambles in the direction of the cliff’s ledge, pushing air with his feet. Too late, we hear a loud ka-boom sound as the coyote hits the pavement below. ‘Darting’ about as a nation, giving little thought to our budget, we give aid to corrupt regimes throughout the world, bail out bloated and unethical banks and save bankrupt corporations, appearing ever-so generous. This lavish aid is available because we, as a nation, are living way beyond our means.

For the past dozen or so years we’ve spent approximately one trillion dollars more than we have in yearly revenue; one trillion more than we generate in taxes each year. Imagine a neighbor living in the fanciest house, having big parties for the neighborhood, handing out hundred dollar bills at Halloween to trick-or-treaters, and buying their own kids new cars for Christmas. “Boy, are these guys wealthy and generous” might be one’s thought. Now imagine discovering the neighbor is doing all of this on a credit card which will never be paid back. “Boy, are these guys corrupt or ignorant,” one might think. As a good neighbor, you smile, wave, say good morning, but behind closed doors, instruct your children: “stay away from the neighbors, they’re in big trouble.” The U.S., like the foolish neighbors and Wile E. Coyote, stepped off a monetary cliff, only to find we’re being held up by thin air – very thin air. The Ka-boom sound is not far behind.

Stay Away From the Neighbors . . .

The U.S. will never pay back its 17.5 trillion dollar liability. Never! It will continue to grow. In a perfect world we would, like Singapore, spend what we take in in taxes, living responsibly. However, our future commitments: military incursions throughout the world, and social welfare, necessitate we budget irresponsibly, living way beyond our means. We do pay interest on these financial obligations though, of under a half trillion dollars a year to those institutions, countries, and individuals who own government I.O.U.’s. Next year, we’ll increase the debt in order to pay the interest. Sound confusing? Ask your Congress persons to explain this smoke and mirrors trick, and watch them squirm attempting to answer.

After the market crash of 2008 the Federal Reserve forced interest rates down to unnaturally low levels, allowing the government and homeowners to borrow at rates which would not occur if free market forces were in play. This low interest rate allowed the U.S. government to borrow even more money; after all, the money was cheap. We got out of the financial crisis by borrowing money. What a deal!

So, in the last 6 years we added an additional 8 trillion to the deficit, all to keep up the illusion the U.S. is still the wealthiest neighbor on the street.

The Bretton Woods Agreement was established in the aftermath of WWII. All business transactions – country to country – would be conducted in dollars. The U.S. dollar was the official “reserve currency,” held for trade purposes. A country that held dollars, in theory held the equivalent in gold, since the dollar was backed by gold. Transactions were on the up-an’-up until 1971 when Nixon took us off the gold standard. The U.S. dollar would henceforth be backed by nothing.

Slowly, ever so slowly, the ascent up the debt mountain began. Debt, a mere four-hundred billion in 1971, by 1981 was nine-hundred billion, then a trillion, two, three, four, steeper and steeper up the mountain as we paid our bills using the national credit card. Today, not surprisingly, many countries are beginning to ‘stay away from the neighbors,’ ignoring the Bretton Woods Agreement. The BRICS countries (Brazil, Russia, India, China and South Africa) are trading among themselves using their own currency arrangements rather than the U.S. dollar. Russia and China recently signed a huge trade agreement using their own currencies. It looks like the neighborhood is beginning to wise-up.

Carville’s Intimidation

James Carville’s desire to ‘reincarnate as the bond market’ in order to bully nations and corporations is not too far-fetched. Bond prices go down (and interest rates up) when there is inflation or uncertainty in the markets.

In a free market, the bond market is a reflection of the future. A lot of future uncertainties equal higher interest rates. However, at this time, the U.S. has historic low interest rates, not seen since the inception of the nation. Through market manipulation and additional debt we have managed to fool laws of economics by keeping these rates down even though the future of the U.S. economically and geopolitically is quite murky. All it will take for higher interest rates will be for bond holders to get skittish about America’s I.O.U.’s and start selling. The 400 billion we pay a year in interest becomes 500, 600, 700 billion and up.

There is no dignity quite so impressive, and no independence quite so important, as living within your means.’

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