Saturday, May 14, 2011

A detailed look at the Federal Debt and the debt ceiling debate

Total outstanding US Federal debt stands at $14.3 trillion. The $14.3 trillion is broken down into two compartments: debt held by the public and intragovernmental holdings. Debt held by the public stands at $9.66 trillion while the intragovernmental holdings is at $4.64 trillion. Debt held by the public is comprised of treasury securities, or bonds, that can be purchased by investors, foreign governments, central banks, you and me.

Intragovernmental holdings refers to revenues that the federal government borrows from social security, medicare, and other government funds. These funds are issued a special nonmarketable "treasury" security. For example, the federal government has borrowed over $2.4 trillion from Social Security, $800 billion from the Civil Service Retirement and Disability Fund, $335 billion from the Defense Retirement Fund, and the remainder from many other government retirement funds. The total amounts to $4.64 trillion. In addition, most recently social security which used to be a source of funding for government operations has now turned into an expenditure. Put simply, whereas before social security revenues exceeded expenditures, thereby allowing the government to spend the excess, now social security expenditures EXCEED revenues. The burden now falls on the treasury market to make up for the shortfall.

Debt held by the public

This portion of the federal debt comprises the vast majority of the $14.3 trillion. This $9.66 trillion is the amount that is owed to persons and entities that have lent the federal government money. It is also this amount that determines the interest rates that treasury securities yield on the open credit market. The biggest holders of treasury securities are as follows:

Federal Reserve: $1.45 trillion
China: $1.1 trillion
Japan: $890 billion
UK: $295 billion
Oil exporters: $218 billion

As you can see the Federal Reserve, China and Japan hold the bulk of US treasury security debt. Interesting how the Fed is now the biggest holder of the debt. By adding up the $4.6 trillion in intragov holdings with the Fed holdings, over $6 trillion of this debt is "owed to ourselves" lol. Wow I wish I could owe money to myself, that way when I go to dinner tonight I can write a check "on myself" and pay "myself" back later. This concept has been proven to end in catastrophe and will again end up in catastrophe, but that discussion is for a later time.

So now we have the debt ceiling debate which is going on longer than I initally thought it would. The last two debt ceiling raises where a non issue and many on the street assumed the situation would be the same for this raising. However, this week we have officially gone past the debt ceiling and the treasury can no longer borrow any amount that would breach this ceiling. Of course there are maturities of treasuries which lower the outstanding public debt but by and large with the fed gov now blowing through a $1.5 trillion deficit, time is running short.

Here is a detailed look at the debt held by the public:

Bills mature in less than 1 year
Notes mature in 1-10 years
Bonds mature from 10-30 years

$9.6 trillion in debt held by the public
$1.6 trillion in bills
$5.8 trillion in notes
$931 billion in bonds
remainder is TIPS and other.

The US has become an Option Arm nation with $1.6 trillion in bills due within the next 12 months! The reasoning for borrowing so much money with short term duration is that the interest rates are incredibly low. Check out the yields on treasury securities:

3 month: .02%
6 month .07%
12 month .16%
2 year .53%
3 year .94%
5 year 1.83%
10 year 3.17%
30 year 4.31%

.02% for 3 month paper! Wow! Fucking A could you imagine if you could borrow money at .02% for 3 months? How about .16% for an entire year? Here is how it works: Say the government issues $30 billion worth of 1 year treasury bills. After the 1 year term is up the treasury must pay the holder the $30 billion back PLUS the .16% interest. .16 of 30 billion is a paltry $48 million. Hence why the government is borrowing short term. Interest expense as a percentage of government expenditures is at a long time low.

The problem with having too much of your debt in short term paper is the risk of a rise in interest rates. Right now the 10 year is yielding a paltry 3.17%, whereas in the inflationary 80's it was over 10%. Even in the easy breezy 90's the 10 year ranged in the 7 to 8% range. The bottom line is that over the next few years it's very likely that we will see a jump in longer term rates. With higher rates comes higher expenditures as a percentage of federal revenues which will put a further crimp on the current fiscal crisis.

As I posted above, treasury notes outstanding are at $5.8 trillion, which have durations from 1 yr to 10 yr. Of the $5.8 trillion in notes, $1.09 trillion is due by April 30, 2012. 1.6 trillion in bills plus 1.09 trillion in notes due within a year equals $2.69 trillion DUE THIS YEAR. Of course this doesnt include interest expense which is estimated to fall somewhere in the $200 billion range so we are getting close to a round $3 trillion in maturity AND interest expense just for the next 12 months. What are federal revenues projected for fiscal 2011? $2.22 trillion. And projected expenditures? Close to $3.8 trillion. Here are the numbers again in line item display:

$1.6 trillion in bills due
$1.09 trillion notes due within 12 months
$200 billion in estimated interest expense
$2.22 trillion 2011 federal revenues (taxes)
$3.8 trillion 2011 federal expenditures
$1.5 trillion expected deficit

So how does the Treasury manage to issue AND pay all this short term debt? Very simply by rollowing over short term paper. Here is an example: Treasury issues 10 billion in paper due in 3 months. One month before the 10 billion is due it borrows from the same entity or other entity another 11 billion. It uses the new 11 billion in new borrowing to pay back the original 10 billion, leaving the remaining 1 billion for expenditures. This is just a basic demonstration but the point is to explain the "rolling over" phenomenon. Estimates state that total GROSS Treasury borrowing exceeds $10 trillion per year. What a way to run the finances of the world's biggest economy.

So now Timmy Geithner is faced with a monster game of chicken coming out of Congress regarding the debt ceiling. He again wrote a letter warning of "catastrophe" if Congress fails to raise the debt ceiling RIGHT THIS SECOND!

In the event that Congress fails to raise the debt ceiling, the Treasury would have to use tax revenues to pay out the coming bills and notes securities, leaving no remaining money for government operations such as social security, medicare, defense, ebt, and the rest of the budget. As I have demonstrated, the amount due this year is greater than all of the projected revenues. The Treasury can borrow as it pays existing maturities but only for so long.

Of course, I expect Congress to relent and raise the debt ceiling from the current $14.3 trillion to $16.5 trillion. But in 18 months or so we will be right back to where we are today, in "dire" need to raise the ceiling to $18 or $19 trillion. How about some basic common sense: if the country can't bear to NOT raise the ceiling with a $14.3 trillion debt, how the fuck will it deal with a monster $16.5 trillion? How about $18 trillion? Where does this end? Opponents say that the economy will be stronger and thus in a better position to deal with the outstanding debt. On the contrary, these numbers scream dollar destruction to me. This double down mentality is absurd, reckless and disastrous for the country. I personally believe that this is the last chance for the country to turn around and get a real handle on the debt crisis. Once we cross this line I fear there will be no turning back, leading to the complete and utter destruction of the US currency. Watch how the federal reserve continues to gobble up more treasuries with the magic of it's printing press. Indeed, the printing press has become our lender of ONLY resort.

As I have explained numerous times on this blog, money is lent into existence. With no borrowing from others the money supply falls. In addition, as money is lent into creation, it must also be repaid, with interest. With households full of debt and shot of credit, the last borrower is the federal government. This is one of the major reasons why the deficit is so huge, as new credit money must be created in order to avoid a horrific implosion of the system. Observe this chart produced by Dr. Martenson:

Per Martenson:

There's a lot going on in this deceptively simple chart so let's take it one step at a time. First, "Total Credit Market Debt" covers everything - financial sector debt, government debt (fed, state, local), household debt, and corporate debt - and is represented by the bold red line (data from the Federal Reserve).

Next, if we start in January 1970 and ask the question, "How long before that debt doubled and then doubled again?" we find that debt has doubled five times in four decades (blue triangles).

Then if we perform an exponential curve fit (blue line), we find a nearly perfect fit with an R2 of 0.99 when we round up. That means that debt has been growing in a nearly perfect exponential fashion through the 1970's, the 1980's, the 1990's and the 2000's. In order for the 2010 decade to mirror, match, or in any way resemble the prior four decades, credit market debt will need to double again from $52 trillion to $104 trillion.

Finally, note that the most serious departure between the idealized exponential curve fit and the data occurred beginning in 2008 -- and it has not yet even remotely begun to return to its former trajectory.

This explains everything.

It explains why Bernanke's $2 trillion has not created a spectacular party in anything other than a few select areas (banking, corporate profits) which were positioned to directly benefit from the money. It explains why things don't feel right, or the same, and why most people are still feeling quite queasy about the state of the economy. It explains why the massive disconnect between government pensions and promises, all developed and doled out during the prior four decades, cannot be met by current budget realities.

Our entire system of money, and by extension our sense of entitlement and expectations of future growth, were formed in response to and are utterly dependent on exponential credit growth. Of course, as you know, money is loaned into existence and is therefore really just the other side of the credit coin. This is why Bernanke can print a few trillion and not really accomplish all that much. It's because the main engine of growth is expecting, requiring, and otherwise dependent on credit doubling over the next decade.

To put that into perspective, a doubling will take us from $52 to $104 trillion, requiring close to $5 trillion in new credit creation during each year of that decade. Nearly three years have passed without any appreciable increase in total credit market debt, which puts us roughly $15 trillion behind the curve.

What will happen when credit cannot grow exponentially? We already have our answer, because that's been the reality for the past three years. Debts cannot be serviced, the weaker and more highly leveraged participants get clobbered first (Lehman, Greece, Las Vegas, housing, etc.), and the dominoes topple from the outside in towards the center. Money is piled on, but traction is weak. What begins as a temporary program of providing liquidity becomes a permanent program of printing money, which the system becomes dependent on in order to even function.

Hence why the monetarists are pumping as much as they are. Based on their models and theory, CREDIT MUST GROW! I'm no PHD but common sense tells me that there is something inherently wrong with a money system that depends on perpetual growth in a world that cannot grow forever. Throw in the corruption, fraud, global wage arbitrage, and higher energy prices and it becomes apparent why credit growth has stalled. In fact it began stalling in the 90's, hence the reason for the dot com and housing bubbles. We needed to grow grow grow.

So these are the numbers that I look at, the numbers that frame my forecast and sentiment for the future. It is incredible how rapidly our fiscal situation has deteriorated in the past 4 years. The fact that we call the "Treasury" department as such is a insult to the word "treasure" which implies something of great value. My solution calls for a serious reduction in federal spending, with everything on the table. Military spending would be the first to go, followed by a tax increase on the wall street machine. Banks would have to adhere to real accounting standards, causing the large TBTF zombines to collapse under their own weight. Surely we can implement some type of controlled demolition of these monoliths. Home prices would revert back to 1994 levels which would be the best thing as mortgage expense would fall to low levels, thereby freeing up desperately needed capital for other underserved areas of the economy. Right now my dad is paying 12k per month for his house (he levered the fuck out of it during the boom). When he eventually goes into default and rents a nice home for $3500 a month, that leaves at least $8500 per month to go into the rest of the economy and not some TBTF zombie. My dad loses his home and the bank implements a write down on it's books. My dad gambled with equity and lost as the bank gambled in extending him too much credit and also lost. The winners are the new home buyers who will spend 800k to buy the house and the rest of the economy as my dad can then blow the remaining $8500 on investments, vacations, whatever the hell he chooses. By and large, foreclosures as painful as they are in the beginning, are actually very beneficial for the economy. It's just that the banksters don't want you to believe or understand this concept.

We can get out of this hole but it would require sacrifice from the entire country. America has basically become a credit junkie, where a cessation of borrowing would lead to terrible withdrawal effects (deflationary depression for a few years) but would save the patient. The other option is increased dosage of credit to the point where the patient dies (hyperinflation). Again these are the numbers, with no political bias behind them.

On a final note, the most important thing we can do right now is prepare prepare prepare! Work any job you can, save as much as you can. If you can squat with family and friends then do it. That's all for now.

PS: I drank 3 cups of coffee before writing this lol. This paper was written in order for you all to better understand the predicament facing the country. My gain and satisfaction is in you obtaining knowledge and an understanding of how the ponzi works.


  1. Awesome post. Keep up the great work! swing through every new post, love the information.

  2. Subprime,

    You might not be a pHD, but your thesis/blog would demolish most of the neo-Keynesian supply side hacks out there.

    Keep up the good work!

  3. Subprime,

    What does one do if one wants to start a business during this national predicament or wants to start a family? This situation seems conducive to neither thing happening for an individual.

    Which is not to say as I disagree, thrift is a quality to espouse during good times or bad, but I'm just wondering how one can go about doing things that one might want to accomplish in life when this much is at stake.


  4. Andy,

    The questions you ask are extremely difficult to answer but I'll do my best.

    These truly are frightening times we live in. There is just so much uncertainty out there. For example Pimco, which is the largest US bond fund, has NO US TREASURY holdings at this time. This shows how little confidence the managers of Pimco have in the US government's finances.

    That being said, it's still possible to undertake wise and prudent investments. If you can provide a product or service which is in demand but in little supply, then go for it. It's also possible to start a family and do all that good stuff. Just do it wisely and on the cheap. Instead of renting a big nice one bedroom, you can share a two bedroom and save decent money on the rent. Although your "standard of living" falls by having to share space with others, it doesnt necessarily mean your quality of life has to suffer. In addition, instead of buying a new car for 20k, you can wheel and deal and find a decent used car for 7k on the private market without getting a loan. Just due your due diligence and market research.

    I've pulled back my spending dramatically and go out way less than I used to. Nonetheless, I find ways to have fun while at home. I bust out the monopoly board and smoke my friends lol. We can play for 4 hours and not spend a dime yet have a great time. Right now I'm just saving as much as I can, and working like bastard (at least 7 days a week every other week). It's time to hunker down but life can continue and still be relatively pleasant so long as we have our health.

    I hope this helps put things in perspective.

  5. @SPJD,

    Thanks. I work fulltime as well and use my weekends to try and get my business running, which I will gladly work at all week if it becomes a profitable enterprise.

    My goal is try and live off the grid as much as possible in a few years: Start my business, move away from LA and live somewhere smaller. Use less oil, do more DYI projects and maybe pick up some other trade. I have little faith in the Washington-NYC-Financial-Military Axis (I hesitate to say Military-Industrial, 'cause we sure don't manufacture anything anymore) to do well by anyone but themselves and their lieutenants. And I have no desire to be complicit in the enslavement of myself or others.

    Keep writing, I will keep reading.


  6. With the Fed starting to talk about raising rates, perhaps some discussion could be had as to its potential impact on graduates from 2007 and earlier (i.e. before GradPlus loans). Many of these graduates carry an enormous debt load and at least some of that debt has a variable interest rate based on prime.

    It would appear that there is a lot of misery ahead for those graduates before 2007 who did not win the law school lottery.

    Furthermore, I just wanted to say that I personally enjoy your blog and I sincerely hope that you keep up the good work.


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