Forgive us our debts, as we forgive our debtors . . .

Financial markets have long watched the 10-year and 30-year treasuries because they have long been considered a good indication of long-term interest rates. While I’m sure they are still interesting, I think a more important number to watch now may be the 5-year treasury bond. You see, a 10-year treasury will mature at a time when, according to the highly optimistic assessment of the Congressional Budget Office, we as a nation will be more than 23.5 trillion in debt. Best-case scenario. Right now, at 14.6 trillion in debt, our country is already standing at the edge of a cliff, its economy incredibly volatile. Increasing debt loads, changing interest rates, and monetary inflation all combine to make the ten-year outlook way too foggy for the 10-year treasury to actually tell us a whole lot about the next ten-year period. And the 30-year treasury, forget about it. The US dollar and the US debt simply will not survive that long — there’s no way to run the math that doesn’t involve drastic inflation or default.

As detailed in a recent article on rollover risk, US federal debt is currently loaned out in a variety of bonds ranging from 1 month to thirty years in maturation dates. But the average time for our debt to mature and be replaced by new bonds, a process called ‘roll-over’, is about 4 years 2 months. The 5-year treasury is currently the closest single bond to the average length of a debt roll-over cycle in the United States. The yield on the 5-year treasury on August 1 was 1.32%. In the last eight days, it has plummeted to just 0.91%. That’s incredibly low. That means that if current annual inflation rates of about 3.7% persist over the next five years, a $100 5-year treasury bond will be ablto buy only what $83.50 could buy today. That means that so many people are rushing to buy 5-year treasuries that the US government is able to sell them to people at an anticipated 16.5% loss. And that’s assuming that inflation stays stable, which is a dangerous assumption, because the fundamentals of US currency lead many economists (pretty much all except the crazies like Paul Krugman) to think that inflation is likely to rise. That’s what happens when you print and print and print money to cover all your needs. Robert Murphy has written a nice little piece on that here.

So why would people accept a guaranteed 17% loss on their investments over the next five years? Easy. It’s because they are much more afraid of what they could lose if they invested somewhere else. They are running to one of the few perceived safe havens left — the US government’s invincibility.

The clumsy three-year-olds who run this country have been allowed to play with matches and gasoline inside the walls of our financial house for about a century now. President Obama talks about adjusting the furniture, and sweeping it up a bit, and maybe doing some serious redecorating, but the fact of the matter for those willing to look is that the house and been engulfed in flames for the last few years. The events of the last eight days or so, to continue the metaphor, are the sound of a massive explosion somewhere within the burning building. We can’t quite make out all the details of the explosion, but we know it’s dangerous. And so people are running to cover in the form of treasury bonds — investments in the house. Hearing the blast, panicked people are running into the burning exploding house.

That’s what dropping rates on the 5-year treasuries mean. That’s how insane things are now. Now, it is true that not everyone is running toward the house. Some people are already out of the house, or are actively running away from it into gold, silver, and a variety of other investments which are essentially bets against the burning house. But the drop in treasury bond yields means that overall demand on the 5-year treasuries is going up. Basically, more people are still running toward the explosion than away from it.

These people who are running toward the explosion are keeping the interest rates on US debt at extremely low percentages. They are gobbling it up at startling rates, which is the only reason a nation 14.6 trillion in debt with a GDP of 14.8 trillion is still able to keep borrowing at the rate of 1.4 trillion per year. But there is a law that governs large crowds running toward a burning building. Eventually the crowds will get close enough to the burning building that they feel the heat and begin to run away. Some people will likely burn to death as the crowd behind them hasn’t yet realized the danger.

All in all, everything averaged together, the US is only paying a 1.4% annual interest on its debt, which, when we consider that we have 3.7% inflation, means that we’re effectively paying an interest rate of negative 2.3%. When the people really start running out of the burning building in more reasonable numbers, the US is going to have to offer debt at real interest rates higher than 0%. Even a mild run on US treasuries would blow real interest rates up to 2% per year, which on top of at least 3.7% in inflation will mean nominal interest rates of at least 5.7% per year.

If that occurs in the next few months, a 4.3% shift upward in interest rates will add an extra 645 billion dollars in interest payments to the federal budget. Considering that we’re already spending 3609 billion a year while taking in only 2202 billion in taxes, 645 added to the federal deficit would blow our annual deficit to 2 trillion. In less than two years that would put us in a worse position than Greece when it was receiving its first bailout. Except that no one is there to bail us out. So we’ll start paying Greece-style interest rates, say, perhaps 8% interest on a debt of 17 trillion by then.

That 1360 billion dollars in interest per year. That’s basically a doubling of our current deficit. As more and more people run out of the burning building, interest rates continue to climb, which in turn fuel the deficit, which in turn requires the US to borrow ever-larger sums of money from people ever less interested in buying our debt, which requires that we offer higher and higher interest rates.

Once interest rates hit 15% on 15 trillion dollars, or 11% on 20 trillion dollars, interest will consume our entire federal tax rolls.

The game will be over before that point. We have no choice: we will default directly or default through hyper-inflation. The only question is how long the period of denial lasts. I can’t imagine it lasting more than ten years. Five sounds more reasonable.

Watch the five-year treasury yields.

We are in a situation many nations have been in, but on a scale and intricacy never before seen.

Hold on tight.

Yes, it is true that the ins and outs of government financing are complicated, but the universal laws of finances still apply beneath the smoke and mirrors. Our day of reckoning is coming, a day when the way the government handles money will change drastically. For the recipients of the trillions of dollars of debt-financed spending — for bankers, for for the old, for the sick, for unemployed persons, for farmers, for single mothers, the flow of free money will be cut off, and balanced budgeting will one way or another occur.

All signs indicate that we are nearer to that terrible day than we would like to believe. Just today government passed an emergency spending measure that will keep government operating until Tuesday. That’s right — four days. Government is now like the spendthrift who discovers he only has enough supplies to keep him going for the next four days.

Now, it is all but certain that government will find some way out of this. Just like for the spendthrift, that doesn’t actually mean that he will be starved into responsibility in the next four days. But it is a sign of things to come.

The end is near, the end of an entire way of doing business, the crumbling of one economic order as it gives way to a future which is uncertain but will undoubtedly not be merely the continuation of the present. And now, a word from William Butler Yeats,

The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world . . .

And if we’re willing to go beyond the mere issue of taxation without representation, we have to look even harder at the morality of the situation.  If somehow only the taxpayers at the time debt was taken on were to be held responsible for its repayment later in their lives, would that really be better?  Well, it would be a little bit better, because it would force voters to think about what they’re doing to their collective selves, but still it’s not as though there’s any real choice even present voters have about the national debt.  I, for example, have only been legal for voting for a year and a half now, (during which time “my share” of the debt has climbed by a whopping $22,227.50).  Am I morally responsible for this $22,227.50, because I am now “represented”?  I think not.  I haven’t had any chance to vote on whether I wanted the government to overspend $22,227.50 in my name.  The only “choices” I’ve been given is the right to make a single vote (which rarely if ever decides anything) between two politicians (who both are part of vast political systems called parties, of which both Republicans and Democrats spend like drunken sailors).  So what we call “representation” is nothing more than my right to cast a vote which will almost certainly make no difference between the candidates who spend my money ahead of time, a vote which, even if it happened by some incredible chance to be the deciding vote would be almost certainly meaningless because pretty much every politician out there is fully participating in selling my future earnings.

So when we see that the national debt is simply a massive load which other people foisted upon each of us, the next logical step is to ask what should be done about this.  Now, there are, conventional wisdom tells us, three basic approaches.  The approach we’re currently trying, considered a “liberal” approach, is paying this generation’s debts (from the last generation) by simply massively increasing the load on the next generation.  Now, of course this cannot be continued forever.  Eventually people will quit handing us money to borrow when they realize we’re unable to repay.  And so there are two approaches left.  One approach says that we should simply tighten our belts, rein in our spending, and pay off the massive debt.  That is, that the current generation ought to pay for the mistakes of the last generation past politicians.  The other approach is repudiation, that is, declaring that we will not pay the debt that is foisted upon us unjustly.

This dilemma is the one currently faced by Greece (and by the US, though we don’t seem to fully realize it yet).  Now, let’s look at this through the lens of libertarianism, which is widely viewed as a right-wing movement.  Libertarianism is about government not meddling in people’s business, which includes less taxation and government spending.  Libertarians, widely considered extremist right-wingers, if they are consistent would therefore advocate that the present generation not be forced to pay for the ridiculous excesses of the past.  So a completely consistent right-wing approach would be to repudiate the debt.  Greece is considering doing this.  But for some reason they’re being called “left-wing” for this:

“There is simply a growing recognition that Greece has got to default, said Rochdale banking analyst Dick Bove. “The riots in the streets showed the decision to repay the debt was not going to be made by the people in Germany, France and Switzerland, it’s going to be made by people in Greece and they’re not going to repay it,” he said. “Anyone seeing the riots is going to recognize that this government is going to be thrown out and anything replacing this government is going to be far more leftist leaning and they’re going to repudiate.”

So I guess that ending taxation without representation is therefore both leftist and rightist.  This is perhaps a sign that our political terminology is badly distorted.  But I guess that’s the inevitable result of running a society not on thinking but on political expediency and desire for immediate gratification of all financial desires.

And on the related subjects of trade deficits and their relationship to the soundness or unsoundness of money, Robert Murphy explains some facts about trade deficits that tend to get ignored.

And if I have somehow managed to point you toward Mises posts and you want to read them in the español, it turns out the Mises blog gets translated into Spanish here.

A bipartisan committee in Congress has released projections for the next ten years.  They estimate that over the upcoming decade, there will be a total of 9.8 trillion in deficits, bringing our debt up to 20.28 trillion.  For those who, like me, simply feel numbness at that figure, that’s almost 1 1/2 times the 14.2 trillion our country produces each year, and over 9 1/2 times the amount of taxes we take in per year.  That would be rather like a broke family making 40,000 a year owing 380,000–a family with rapidly rising costs and retiring grandparents who will soon have to be supported.

Now, unless there is a radical change in that family’s finances, the family will, one way or another, have to find a way to default on its debts.  In the U.S. government’s case, there are a number of ways that could be done.  We could just default, but that would be politically ugly.  But I rather suspect that we’ll try to shrink the real size of the debt by means of inflation–using the government’s ability to produce dollars to increase the dollar supply and decrease the value of the dollar.  And it’ll take a big decrease in the value of the dollar.  And this will result either in the financial pain that always accompanies hyperinflation, including severe pain for all lenders and money-holders of all sorts along with disruption of trade, or else it will lead to the logical end of every fiat currency:  the crack-up boom.