The Fantasy of U.S. Government Debt Funding

In the absence of foreign buyers, increases in government fiscal deficits and the concurrent borrowing requirements induce higher domestic household savings to cover government spending. In such an environment, all of the government IOUs become assets of households, which have been conveyed implied benefits, if not immediate gratification, from the additional government spending. It is, however, up to the households (or future households if the charade can persevere past the current generation) to repay the government obligations through higher future taxation, but direct or indirect household ownership of U.S. government obligations implies that they will, in effect, be repaying themselves. In reality, households have done nothing but borrow from their own future to finance current consumption while delegating consumption decisions to corrupt and self interested politicians. Rather than allowing economic forces to direct individual consumption decisions, households have authorized the government to spend prolifically on their behalf without holding them responsible for the government balance sheet. The growing concern about sovereign defaults can and will spread to the U.S. economy if politicians do not come clean with the American people about the limitations on what the government can realistically afford.

Quick Facts:

• The current budget deficit as a percentage of household income is 13%. This implies that, absent substantial purchases by foreign governments, U.S. households must have a personal savings rate of over 13% which all must be used to finance public debt issuance as opposed to more productive endeavors. The current personal savings rate (as a percentage of disposable income) is 4.8%
• Given President Obama’s budget proposals, the Congressional Budget Office projects trillion dollar deficits for the next decade and, as a result, skyrocketing interest costs which will quickly limit the government’s ability to address future shortfalls.
• Interest costs will rise from 8% of current government revenues to in excess of 25% in the next ten years. If U.S. treasury rates rise 2% above current forward rate levels, interest costs will consume over 35% of the federal budget within 10 years.
• U.S. Treasuries held by foreigners has increased steadily to near 50% over the past decade, but recent calls by China and other major creditors to diversify reserve assets across various currencies suggests that foreigners will cease to be the primary source of funding for government fiscal deficits. Future deficits must, therefore, be financed by U.S personal savings which will crowd out investment in more productive endeavors. A reduction in investment will restrain future GDP growth and limit much needed employment gains as the U.S. struggles to emerge from the devastating grip of the recession.

Foreign Holders of U.S. Treasuries as a Percentage of Total Outstanding (Source: Bloomberg)

The Sovereign Debt Crisis: Money for Nothing

Click Here to Expand Image (Source: Bloomberg)

For the next 5 years, there will be $50-80bn per MONTH of U.S. Treasury maturities that will need to be rolled. That amount is just to refinance the existing marketable debt (e.g. not Social Security / Medicare "Trust Fund" obligations). It is safe to say that there won't be any budget surpluses in the foreseeable future so this monthly funding demand can only grow. As the U.S. government continues to run $1 trillion budget deficits, their fiscal imprudence requires additional funding of $80-100bn per month to finance current spending. There obviously has been a much stronger and persistent bid for treasuries than many market observers ever expected, but the resolve of these investors faced with massive monthly issuance leaves one to ponder the tipping point that finally results in primary dealers balking at the prospect of absorbing the majority of another treasury auction.

Regardless, all signs point to an impending “day of reckoning” where the most indebted governments must finally confront the untenable obligations they have hoisted upon the people. All of the "emergency" measures, "stimulus" packages, and new entitlements will only hasten the process as the final days of the spendthrift regimes draws near. The era of “Money For Nothing and chicks for free”,once celebrated by the band Dire Straits, will be nothing but nostalgia for those that lived the good life in the days of extravagance and a general lack of accountability.