The 'clock' is ticking on the next financial crisis... This 'Goldilocks' economy won't last forever... A critical announcement from the U.S. Treasury... The government's debt problems are about to get much worse...
Today, we're taking a break from our ongoing coverage of the 'Melt Up'...
For an important update on the bust – or the "Melt Down," as our colleague Steve Sjuggerud has dubbed it – that we believe is sure to follow.
You see, the U.S. government issued a critical announcement this week... and officially kicked off the countdown to the next financial crisis in the process.
Let us explain...
Like the last great boom in the 1980s and 1990s, this boom is being fueled by one thing...
A massive increase in government debt. As Porter explained in the November 17 Digest...
I won't bore you with the details (I promise). But consider this...
For a period of almost 20 years – between 1979 and 1998 – the 10-year average growth rate in U.S. federal debt was more than 100%. That first big "spurt" of U.S. debt growth peaked in 1991 (with a 10-year increase in federal debt of 228%) that saw total federal debt per person in the U.S. grow from $3,700 to $20,000 by 1998.
As I'm sure you'll recall, the period between the early 1980s and the 1990s was generally fantastic for the stock market and for investors. At the beginning of a massive credit boom, everything seems great. That's because when credit growth far exceeds savings, it allows an economy to consume far more than it's producing.
This "pulls forward" consumption, magnifies economic growth, and increases spending and usually wages, too. It's a boom!
But by 1998, so much consumption had been pulled forward that not enough global aggregate demand was left. A huge bust emerged, which hit commodities and emerging markets. Russia defaulted. Eventually, these problems caused the tech and telecom bubbles to burst, and the U.S. saw a severe bear market. Tech stocks fell about 80% from their peak.
We've seen almost the same thing happen again over the past decade...
U.S. government debt has again more than doubled on a rolling 10-year basis, peaking at 137% in 2012. On a per-capita basis, federal debt has more than tripled since 2000.
Yet there is one stark difference today...
During the last boom, we heard plenty of warnings about growing federal deficits and debts from politicians on both sides of the aisle. That hasn't been the case this time. As Porter explained...
Since this boom began in 2009, almost nobody has paid any attention to this massive increase in federal debt. You haven't heard a word about our deficits from our politicians. Nobody cares. Why? Because since 2009, these debts haven't caused our country's borrowing costs to rise.
Even though total federal debt outstanding has increased by 126% since 2008, our borrowing costs have fallen. We're still paying about the same amount in interest on this debt as we did back in the early 1990s, when our national debt was only 22% of the size of today's burden.
The thing that matters to policymakers is how much the debt costs to maintain, not how much it costs to repay. That's why you haven't heard anything about it.
This 'Goldilocks' situation won't last forever...
In fact, we believe it is already ending. Most folks just haven't realized it yet.
As you know, the Federal Reserve has already begun raising short-term interest rates. The Fed has raised rates five times since December 2015 – from basically 0% to near 1.5% today – and is on pace to raise them again in March.
The following chart shows what this has already done to the U.S. government's borrowing costs...
As you can see, these costs plummeted as the Fed slashed interest rates during the financial crisis. And just as Porter noted, they remained relatively stable for several years after despite a massive increase in borrowing.
However, that is no longer the case. Net interest payments started moving higher as the Fed began raising rates two years ago. Today, they exceed $260 billion per year for the first time in history.
But remember, interest rates are still near the lowest levels in history. Take another look at the dark line on the chart... Even after the Fed's recent hikes, short-term rates are more or less where they were at the bottom of the last rate-cutting cycle.
Of course, this isn't the only significant pressure on interest rates today...
As regular readers know, the Fed has also begun to unwind its massive portfolio of U.S. Treasury and mortgage debt.
Rather than continue to "roll" this debt forward as it matures, the Fed is now simply letting it expire. Since October, it has been allowing $10 billion worth of this debt to expire every month, and it will be increasing this amount by $10 billion per month each quarter this year.
The result will be a reduction of more than $400 billion in demand for this debt in 2018 alone... and another significant tailwind for higher rates.
If these trends simply continue as expected, the government's borrowing costs will rise rapidly.
But this week we learned that the reality could be even worse than we imagined...
Yesterday, the U.S. Treasury announced that it will soon dramatically ramp up debt issuance for the first time in nearly a decade. As the Wall Street Journal reported last night...
The Treasury said Wednesday that the size of its regular auctions of bills, notes and bonds were going up in the coming months.
A group of private banks that advise the Treasury – known as Treasury Borrowing Advisory Committee, or TBAC – estimated the Treasury would need to borrow on net $955 billion in the fiscal year that ends September 30, up substantially from $519 billion the previous fiscal year, according to Treasury documents released Wednesday. The TBAC group estimated that would rise further to $1.083 trillion in fiscal 2019 and $1.128 trillion in fiscal 2020.
It would mark the first sustained acceleration in Treasury borrowing since the 2007-2009 recession, when the financial crisis caused a rush of government borrowing to fund financial bailouts and increased safety net spending at a moment of declining in tax revenues.
But that's not all...
In addition to issuing more debt and increasing the size of its individual debt auctions, the Treasury also said that it will be shifting the make-up of this debt.
Since the financial crisis, the Treasury has issued a much greater proportion of long-term debt than usual. According to the Journal, the weighted average maturity of Treasury debt now sits at more than 70 months – its highest in decades – compared with just 49 months in 2008.
But now, the Treasury intends to reverse this trend, and begin issuing more short-term debt instead.
This is a big deal...
While the Treasury believes this shift will help offset the reduction in Federal Reserve demand for longer-term debt, it could have two serious consequences down the road...
First, the additional supply of short-term debt will push short-term rates even higher, and hasten the yield curve "inversion" that historically triggers a recession.
Second, it could make the government's borrowing cost problem exponentially worse.
You see, when the Treasury issues longer-term debt for 10 or 30 years, it typically pays a higher interest rate initially than it would to issue short-term debt. This is intuitive. But it gets to "lock in" that rate until that debt matures.
When it issues short-term debt, it typically pays a lower rate initially, but must reissue that debt at market rates much sooner.
In short, this shift will make the government itself even more vulnerable to rising rates... just as rates are beginning to rise from historic lows.
What could possibly go wrong?
Again, this is no reason to panic...
These problems may not "matter" for months... or even years.
But they will matter eventually. And the clock is now ticking.
New 52-week highs (as of 1/31/18): Automatic Data Processing (ADP), Amazon (AMZN), Boeing (BA), PowerShares Chinese Yuan Dim Sum Bond Fund (DSUM), KraneShares E China Commercial Paper Fund (KCNY), Lockheed Martin (LMT), Mobile TeleSystems (MBT), Microsoft (MSFT), and Travelers (TRV).
A quiet day in the mailbag. Let us know what you're seeing at feedback@stansberryresearch.com.
Regards,
Justin Brill
Baltimore, Maryland
February 1, 2018