Bubbles abound. The UK government stands accused, by way of its support in offering second-loss guarantees for home buyers who can’t afford the down-payment on a property, of feeding the frenzy. Now the Bundesbank has come out and pointed to a property bubble, albeit in the price of investment properties. The low interest rates of the past few years have effectively pushed savers into any asset class which is not cash.
However, the bubble of all bubbles is the one least mentioned, namely the national debt – I don’t mean that the bubble is solely in the now staggering size of the amount of money we, the taxpayers, owe to all and sundry in order for our leaders to get re-elected. I am not sure what the reverse of a bubble is called but it is there in the form of interest payments.
… as economic momentum continues to shift towards China and South East Asia and as convertibility and liquidity begins to increase in the renminbi, risk premia which we have so far never experienced might begin to appear in the pricing of the US curve…
As we have watched deficits spiral and the national debt stock expand over the period since the collapse of the credit bubble – yes, we have fought the effects of debt by piling on more debt – we have also been graced with significantly lower interest rates. In effect, the cost of borrowing had been falling more or less in line with the growth of the debt mountain, thus having the effect of the cost of debt service remaining more or less stable and thus never quite making the headlines.
Meanwhile, as we sit and wait to see what today’s delayed US Payroll number will bring and as we try to find reasons for Fed tapering to be postponed a bit longer. I don’t think that analysts are expecting any fireworks from the Department of Labor and as the effects of the government shut-down won’t affect the September numbers which we are getting today, irrespective of how the labor report looks, there will be fingers pointed towards the October releases with the comment that until we see those, nothing has much validity.
Deterioration
But, that aside, a turn in the interest rate cycle accompanied by a sense that Uncle Sam may be a deteriorating credit could see longer rates continue to rise, irrespective of how tightly Fed funds remain nailed to the floor. Now, if debt is 100% of GDP and tax take is, as in the US, 27% of GDP, and rates are at 2.5% across the yield curve, then 10% of all taxes goes towards servicing debt. As debt rises and rates rise, the impact of interest charges grows and the debt spiral accelerates again. Far be it from me to suggest that 10 year treasuries will be yielding 4½% or even 5% within the foreseeable future but if, as and when they do things will get fiscally very tight in Washington.
The deterioration in the value of the dollar appears to reflect an equal deterioration in the faith that the international community has in the United States – and I’m not merely talking about the recent nonsense over the budget and the debt ceiling but, in a broader sense, that nobody in a position of responsibility cares that government finance has effectively spiralled out of control.
Treasury yields so far do not have a measurable pricing element reflecting currency risk built into them but as the dollar has always benefited from being the sole global reserve currency, they have not had to. However, as economic momentum continues to shift towards China and South East Asia and as convertibility and liquidity begins to increase in the renminbi, risk premia which we have so far never experienced might begin to appear in the pricing of the US curve and with it the drain on federal finances by way of interest expense as a percentage of total government income (not spending) could increase.
So, while we are all still worrying about what effect tapering might have on generally inflated asset prices, both financial and real, there is a yang to the ying which so far rarely, if ever, is taken into account. Falling deficits do not mean reduced debt, just debt which increases at a reduced pace. Add 100 or 150 basis points to cost of servicing that whole lot and you understand the need to take an even sharper pencil to the budgetary process. Debt servicing cost is still in an unmarked can, yet to be kicked.
Meanwhile, we will watch the non-farms pitch up on screen today in the knowledge that they have been overtaken by events, but in the absence of either alternatives or imagination, they will be given a fair dose of the usual royal treatment.