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What’s Really Worrisome About Treasury Debt: Not Its Rating—Its Interest

So on Monday, Standard & Poor’s cut its ratings outlook for U.S. sovereign debt—and the markets had what can only be described as a tizzy.  

Stocks fell—commodities rose—I noticed things were off when my gold ticker shot up a full percentage point in under sixty seconds. Yikes! (Well, actually, as far as my own portfolio goes, it was more like, Yeay!)

Tons of people started scratching their heads, stroking their chins, and pompously wondering What It All Means.

Oh brother. Like Capt. Willard said: The bullshit piles up so fast, you need wings to stay above it. Most of the navel gazing was a waste of time—the lone discussion that I’d recommend was the New York Times’ “Room for Debate”, which more or less summed up smart-money thinking on the S&P announcement. (Paywall, but if you really want to read it, refresh the page, then stop the refresh before the page fully reloads.)

My own thinking is that the whole S&P announcement is meaningless—literally a non-event. 

What really matters is something people are starting to consider, as inflation begins to rise, and which the S&P announcement alludes to: The colossal interest payments on the U.S. fiscal debt. 

First, let’s put away the S&P nonsensical non-event: 

If you start analyzing the rating agency’s announcement from any angle, you realize it is nothing more than a blip in The Downward Trajectory. 

First of all, a “downgrade in the ratings outlook” doesn’t mean that U.S. Treasury bonds have lost their AAA-rating—it means that in the next two year, S&P will review the rating it gives them. And then after that review it might lower the AAA-rating. It’s basically the S&P saying to the Treasury bonds, “Play nice, or else I might be forced to think about punishing you—maybe.” So in and of itself, the announcement signals nothing. 

Second, the S&P and everyone else is acting as if its rating matters—as if Standard & Poor had even a shred of credibility and respectability left, when really, it doesn’t. After all, this ratings agency was busy whoring itself out to the mortgage markets, effectively selling ratings to the highest bidder, slapping that precious AAA-rating on all sorts of assets that were garbage—the garbage that created the real estate bubble, and directly led to the 2008 Global Financial Crisis. We don’t call the crap they rated AAA “toxic assets” for no good reason—Standard & Poor was a key player in creating these toxic assets, and the ensuing crisis. 

Third, the S&P is highlighting a fact that everybody already knows: Treasuries are nowhere near as gilded as people would like to believe. Hell, I wrote about Treasuries being the new and improved toxic asset—in August. And if you don’t believe me, believe in PIMCO: Bill Gross and Mohamed El-Erian are out of Treasuries—that’s right, PIMCO! Out of Treasuries! That’s like McDonald’s deciding not to buy any more hamburger meat. 

Now, a lot of people are saying that S&P’s announcement is really a wake-up call for the politicians—or the markets—or the people—or a wake up call for someone at any rate. But really, a wake-up call for whom? (Is it “who” or “whom”? I always get them mixed up.) 

The people who matter in this situation—that is, the people who can make a change in the Treasury bond market, be it government officials or market participants—have already cast their lot: The government officials by doing nothing, just a lot of “We’ve got to bring down the deficit!” hand-wringing, while they nibble at the edges of the problem instead of taking a great big bite out of the deficit; the market participants by getting out of Treasuries altogether—or else shorting them outright. 

So the change in the S&P’s rating outlook of Treasuries means absolutely nothing. The S&P’s announcement doesn’t matter. 

What matters isn’t the credit rating of Treasury bonds—the smart-money consensus is right: Treasuries will never default, period.

What matters is the interest payments on the U.S. fiscal debt. （真正重要的是美国政府的债务利息支付）

Right now—in the Federal Reserve-manufactured Funny Money Universe of zero interest rate policy (ZIRP) and debt monetization via Quantitative Easing 2 (QE-2)—the Treasury Department has shelled out over $215 billion in interest since the start of fiscal year 2011. The total is projected to be over $420 billion for the year. 

This on a FY 2011 deficit of $1.6 trillion.

So roughly one in four dollars the Federal government borrows goes to pay the interest on the debt. 

Or looked at another way: About 2.8% of the United States’ gross domestic product goes to pay interest on the Federal debt. That’s bigger than any other individual player in the U.S. economy except the Federal government itself. It’s bigger than mostsectors of the U.S. economy—including Technology, Transport, or Education. That’s right: The interest on the Federal government debt is bigger than those entire sectors. Sad but true.

Or looked at still another way: About 12.2% of the total U.S. government’s expenditures ($3.45 trillion) goes to pay the interest on the Federal debt. That’s more than every single government department except Defense—the fourth biggest expenditure overall, behind defense, Midicare/Medicaid and Social Security. (目前美国政府支出中12.2%用来支付债务的利息，纯粹利息支付，仅次于国防，医疗保险补助，社会保障）

Scary when you look at it that way, huh? 

And what’s scarier still, this is all going on in the Fed’s Funny Money Universe—ZIRP, with QE-2. 

In other words, these are ideal conditions for the Federal government to be carrying such a monstrous debt load. The Long-Term Composite Rate is at 4.1%, and the Fed is printing roughly half the FY 2011 deficit via QE-lite and QE-2. In these ideal conditions for the Federal government to be carrying debt, the interest is $420 billion!

(即便目前有QE2，长期利率很低，光利息支出就有4200亿)

What happens when these ideal conditions no longer apply? What happens when QE-2 ends in June, like it’s supposed to? What happens when ZIRP ends because inflation is so high it can no longer be finessed away, and the Fed has to at least give theperception that it is trying to halt inflation by way of interest rate hikes? 

You don’t need a whole spreadsheet to crunch the numbers: As QE-2 and ZIRP both end, the Federal government will find that its interest payments will grow—rapidly, and I’m thinking catastrophically. 

I argued last week that QE-2 would not end in June because the Federal government cannot afford to have it end: The Treasuryneeds the Federal Reserve to keep on buying its debt via QE-3, because there are simply not enough buyers for Treasuries at their current yields. My position is that QE-3 will start immediately after the end of QE-2. A lot of people disagree: They think 3-4 months will pass after the end of QE-2—and then the Fed will start up QE-3, big time (potatoe, potato, tomatoe, tomato, I wish we could call the whole thing off . . .). 

But setting aside for the moment continued central bank monetization of the Federal government debt by way of a possible QE-3, let’s concentrate on interest rates—just interest rates: 

My back-of-the-envelope numbers say that each basis point of Federal Reserve interest rate hikes will translate into about a billion dollars a year in additional interest—and that’s being generous. (The Scrooge Number is, a 0.01% hike in the Fed funds rate translates to $1.25 billion a year in additional interest payments.) 

Thus a measly 0.25% hike in rates will turn into $25 billion in additional interest payments a year—at least. Maybe even as high as $31 billion in additional interest payments—with just a 0.25% hike. And as regards a full-on, inflation-fighting hike of 1.5%? That would add an additional $150 billion in interest payments—just like that. (fed每加息0.25%，每年因此增加的纯利息支出就是250亿美元，甚至可能因为债务总量的增长，这一数值会到310亿美元，仅仅是利息支付，不包括还本。如果加息到1.5%,那就意味着每年至少多1500亿的利息支付)

An additional $150 billion in interest payments is something the Federal government simply cannot afford. The United States cannot afford it. (而这1500亿的利息支付，对于老美政府来说，根本无法承受：要么多借钱，从而更多还利息，恶性循环，迅速崩溃，要么加税，政治自杀，要么砍福利，一样是政治自杀)

So in other words, the United States cannot afford inflation. Or more properly speaking: The United States’ fiscal balance sheet cannot afford to fight inflation. （所以，美国现在的财政状况决定了fed根本没有升息的空间，也没有对付通胀的本钱。一旦出现通胀，Ben只能选择无视，或者说那是暂时的）

Think about it: If there is a rise in inflation, then the Federal Reserve would have no other option but to raise interest rates at least a couple of percentage points—

—but the Federal government cannot afford such a drastic rise in rates. Not when a 1% rise in rates translates into an additional $100,000,000,000 in yearly vigorish.

Historically, a real inflation-fighting approach means raising rates roughly 4.5% above the annualized rate of inflation: That’s what Paul Volcker did in 1980, to reign in the spiraling inflation produced by the ‘79 Oil Shock. (See here for my discussion of that crisis, and where I get the 4.5% figure.) And even with such a massive rise in interest rates, it still took Volcker almost four years to bring inflation to heel—which gives lie to Ben Bernanke’s arrogance in thinking that inflation can be cut off as simply as turning off his printing press. (从1979年的经验看，当一个央行真正负责的要控制通胀时，利率应该高于通胀率4.5%左右，如果Ben现在这么干，自己算算吧，盖特纳每年要多出多少血？对应的利息支付占政府支出又是多少？又得多举多少债？对应的主权评级恐怕连A都没了，更别说加息对房地产市场是什么作用了)

If a similar scenario were to happen today—that is, a sudden and grotesque rise in inflation that simply cannot be explained away, and a determined effort to fight this inflation by way of the only tool available, which is severe and sustained interest rate hikes à la Paul Volcker—then the Federal government would find its interest payments rising by multiples from its current levels. To mimic Volcker’s approach—a Fed funds rate jump to just shy of 20%—would mean an additional $2 trillion a year. In just interest payments.(如果利率如同1980年那样升到20%，仅仅利息支出就可以吃掉联邦政府的全部收入，别的啥都不用干也干不了了，包括美国总统到大兵的薪水都没了)

That won’t happen, of course. If it ever did, Ben Bernanke would be dragged from the Eccles Building and lynched right there on Constitution Avenue.

But a bump up by a couple of percentage points is possible. And just such a modest bump—just a mere 3% above its current levels—would represent $300,000,000,000 is additional yearly interest payments.

How would such a bump up in interest payments be financed? Simple: Either more debt issuance, or cutting spending.

We have seen—depressingly—how spending cuts will never happen. ‘Nuff said.

On the other hand, the political class irrespective of party affiliation is more than willing to issue more debt, in order to cover up its failure of leadership.

Yet to add on only $300 billion per year to the deficit, in order to finance the interest on the debt, will push the deficit to over $2,000,000,000,000 per year—nearly 15% of the United States’ gross domestic product.

The United States can’t afford such a rise in the cost of borrowing. It simply cannot raise the cash to pay such a mind-numbing amount of interest. There simply aren’t enough buyers of Treasury bonds in the world to finance that level of debt. There just aren’t, end of story.

The one—the only entity that could absorb that level of Treasury issuance would be the Federal Reserve. And the only way they could absorb that amount of Treasury issuance is by printing money:

QE-∞ (结论: Ben不会坐视不理，QE to infinity)

My sense before was that the clowns running the circus—Bernanke in particular—didn’t realize that inflation was on the rise. But thinking the problem through from this end of the telescope—that is, seeing how a rise in rates would cripple the ability of the Federal government to find buyers for its massive issuance, which would mean that Federal Reserve money-printing would be the only solution—I’ve changed my mind. I now better understand—and appreciate—what The Bernank is up against, and what he’s trying to avoid. And no, I’m not being sarcastic:

Bernanke realizes that inflation is on the rise—it’s plain for all to see. But he realizes too that if he acknowledges that inflation is on the rise, he’ll be forced to raise rates. And if he does so, he either bankrupts America—because the U.S. cannot afford to pay the higher vig a rise in rates would bring about. Or he breaks the dollar—because the Fed would be forced to carry out QE-∞, in order to finance the Federal government deficit.

So instead of raising rates—which would bankrupt the American government and/or force Argentine-style money-printing via QE-∞—Bernanke is trying to pretend inflation doesn’t exist.

About 300 years ago, Bishop Berkeley asked the question, “Does a falling tree make a sound if there’s no one around to perceive it?”

I suspect Ben Bernanke will leave us with an equally famous paradox: “If a central banker refuses to acknowledge there is inflation, will prices remain stable at the supermarket?”

I suspect not.