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The Day the U.S. Treasury Doomed America

Interest-Rates / US Bonds Oct 19, 2011 - 04:34 AM GMT

By: Money_Morning

Interest-Rates

Best Financial Markets Analysis ArticleMartin Hutchinson writes: In the mid 1990s, when I was working as a U.S. Treasury advisor to Croatia, I met with the managers of the U.S. Treasury's debt.

In what would turn out to be terrific advice, the Treasury officials suggested that we extend Croatia's debt maturities so the Central European country wouldn't have to refinance too often.


So in gratitude, I offered the U.S. officials some counsel of my own.

I told them they should follow their own counsel and lengthen the U.S. Treasury's average debt maturities, then about six years.

The Treasury officials should have taken my advice. But instead they ignored me and did the exact opposite.

The upshot: Today the United States' debt maturities are among the shortest in the Organization of Economic Cooperation and Development (OECD), and U.S. refinancing costs are exceptionally large.

So if you're already worried about soaring budget deficits and the solvency of the United States, brace yourself - it's only going to get worse.

Refinancing Risks
The U.S. Treasury had more than one opportunity to follow my advice. At the time we opted to extend Croatia's debt maturities, other countries went the other way - with devastating fallout.

For instance, the Ukrainian hryvnia Treasury bill program - where the vast public deficit was financed with 18-month T-bills sold to greedy Merrill Lynch and other foreigners at interest rates above 15% - was one of the major disasters of the 1997-98 crash.

In spite of that outcome, and despite my advice, the U.S. Treasury took the opposite tact by abolishing the 30-year bond issue in 2001. The belief at the time was that Treasury surpluses were so assured that there was no longer any need for 30-year money.

There are two problems with this: First, when interest rates rise, their additional cost will feed through to the budget remarkably quickly, making the financing problem even worse. Second, it increases the risk that at some stage, the U.S. Treasury may not be able to raise the money.

Average Treasury bond maturities reached a low of 50 months in 2009. They've since been lengthened a bit to 62 months, but that still leaves the U.S. Treasury with a major refinancing risk. The Treasury will have to refinance some $2 trillion of outstanding debt in the next year - and that's in addition to the $1.5 trillion of new debt it's going to have to issue in that time.

That doesn't leave much room to maneuver if markets get sticky. It also leaves a serious potential budget hole.

Five-year Treasuries currently yield 1.12%. Since consumer price inflation is currently 3.8%, a more normal yield would be close to 6%, or 2% above the rate of inflation.

However, that implies an average 5% rise in interest rates for Treasuries with an average maturity of 62 months. With $3.5 trillion of Treasuries being issued every year, such an increase would boost interest costs by $175 billion in the first year, $350 billion in the second year, and so on up to $825 billion in the fifth year. And by that time, with the U.S. financial position getting steadily more dire, interest rates would probably have risen further.

The conclusion is inescapable.

When interest rates rise - and I very much doubt U.S. Federal Reserve Chairman Ben Bernanke will be able to hold them flat until 2013 - the deficit increases from the Treasury's refinancing will dwarf any feeble attempts by Congress to tame the country's debt.

That means the current $1.5 trillion deficits will quickly rise to $2.5 trillion, and the debt levels will spiral out of control.

U.S. Treasury bulls frequently tell us how superior the U.S. position is to that of Japan. Japan currently has debt level of more than 200% of gross domestic product (GDP), compared to roughly 90% for the United States, when you include Social Security trust funds.

But what these bulls are forgetting is that Japan sells most of its debt to domestic investors and banks, so it has to worry much less about a failure to find new support.

More importantly, the Japanese government has been increasing its issuance of "super-long-term bonds" of 30-year and 40-year maturity. Its average issue maturity now is 93 months, fully 50% longer than in the United States - thus its annual refinancing needs are one-third less, in relation to the size of its debt.

If interest rates rise, it is the U.S. government debt managers, not the Japanese authorities, who will be committing hara-kiri.

Source : http://moneymorning.com/2011/10/18/day-us-treasury-rejected-my-advice-and-doomed-america/

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Comments

Pete
24 Oct 11, 11:01
countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries

http://www.moneyteachers.org/Foreigners+Dump+Treasuries.htm According to Zero Hedge, countries outside of the U.S. dumped 74 billion dollars in U.S. Treasuries, most of it over the weekend:

"Over the weekend, we observed the perplexing sell off of $56 billion in US Treasurys courtesy of weekly disclosure in the Fed's custodial account (source: H.4.1) and speculated if this may be due to an asset rotation, under duress or otherwise, out of bonds and into stocks, to prevent the collapse of the global ponzi (because when the BRICs tell the IMF to boost its bailout capacity you know it is global). We also proposed a far simpler theory: "the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise - China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived." In hindsight the Occam's Razor should have been applied. Little did we know 5 short days ago just how violent the reaction by China would be (both post and pre-facto) to the Senate decision to propose a law for all out trade warfare with China. Now we know - in the week ended October 12, a further $17.7 billion was "removed" from the Fed's custodial Treasury account, meaning that someone, somewhere is very displeased with US paper, and, far more importantly, what it represents, and wants to make their displeasure heard loud and clear. (Source)

Undoubtedly, the Chinese and other countries have recently discovered that Italy and Greece, with smaller debt to income ratios than the United States, are less riskier and carry a higher rate of return. This is because, unlike the US, the Rothschild/Rockefeller bond rating agencies have trashed their country's debt ratings, forcing them to pay a much higher interest rate than U.S. Treasuries. Hey, if you take the risk, you might as well earn the reward!


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