05.04.2012 0

Treasury postpones decision on floating interest rates

By Bill WilsonThe U.S. Treasury on May 2 postponed a decision on whether to issue a new type of debt that would allow interest rates to float with market conditions. These would be like an adjustable rate mortgage, except for sovereign debt, wherein interest rates would adjust over time instead of being at a fixed rate.

For now, the Treasury is saying it needs more time to study the issue before coming to a final decision. So, let’s help that along.

With interest rates already at record lows, does it make sense for the Treasury to put American taxpayers into an adjustable rate payment plan? Isn’t that risky?

Won’t rates rise?

Especially with $15.6 trillion of debt, $5.9 trillion of which is coming due in the next five years and must be refinanced, the question of how much interest will be paid is of considerable importance to taxpayers. Based on the current size of the debt, for every percentage point rates rise, taxpayers would owe an additional $156 billion in gross interest payments every year.

So, won’t interest rates — currently at about 2 percent on 10-year treasuries — eventually rise, leaving taxpayers with a ghastly bill to be paid?

The short answer is that rates should have already risen. What’s been keeping them down is aggressive intervention by the Federal Reserve to purchase treasuries — i.e. quantitative easing — as a deliberate policy to drive down borrowing costs.

As revealed by Bloomberg News’ Caroline Baum, the Fed purchased 61 percent of net Treasury issuance last year alone, which has been masking a decline in demand for U.S. debt. Since the beginning of 2011, the Fed has increased its treasuries holdings from $1.03 trillion to about $1.67 trillion today, a 62 percent increase.

A grain of salt the next time you hear how “investors” are fleeing to the relative safety of U.S. treasuries off of bad economic news in Europe and elsewhere. In reality, when the Fed is buying over half of the government’s debt as it’s issued with printed money in an effort to push down rates, when those rates actually drop that is hardly a valid indicator of real market sentiment.

All of which makes the question of whether interest rates will eventually rise significantly a political one, rather than an economic one based on data. If solely left to market forces, yes, rates would rise. But will Washington, D.C. ever really allow that to happen?

Mounting debt burden may make higher rates unlikely

The U.S. paid $454 billion in gross interest payments in 2011 — including those to the Social Security and Medicare trust funds. That means, on average, taxpayers are being charged an average 3 percent rate on the total debt, which is fairly low by historical standards.

If average rates were to normalize to, say, 5 percent by 2022 when the national debt is expected to climb to $25.9 trillion, suddenly the annual gross interest expense would spike to more than $1.3 trillion. That’s more than half of the $2.3 trillion presently being collected in taxes.

The Obama Administration had better hope interest rates don’t go up. And that there is a robust economic recovery followed by rapid increases in tax revenues, for that matter.

Otherwise, an interest rate hike would be devastating to the U.S. Treasury and, more importantly, to U.S. taxpayers expected to foot the bill. Therefore, the Treasury likely would not contemplate a floating interest rate for U.S. debt if it was not highly confident that the Fed would indefinitely continue to hold down interest rates.

Or, push them down even further.

One of possibilities of a floating interest rate is that rates, particularly on short-term debt issues, could actually go negative. This would likely help the Fed to push down longer-term rates even further than they already are — which may be the real goal.

This would then allow the government to roll over the $5.9 trillion of debt coming due over the next five years into long-term 10 or 30 year notes at extremely low interest rates.

For reference, consider the case of Japan. There 10-year bonds only go for about 0.89 percent. If that were the average interest rate here, annual gross interest on the debt would only be about $139 billion instead of $454 billion. Such a low rate would make interest costs that much more manageable for Treasury and in the Congress, resulting in $315 billion in savings every year.

Consequences of keeping interest rates too low, too long

But before you nitwits on Capitol Hill jump for joy, consider the perverse relationship this would cement between the Fed and the Treasury.

By crossing this Rubicon, the downside risks if rates do rise would be multiplied exponentially. So, the political pressure would be for the Fed to never allow rates to rise again for the rest of our lifetimes, lest taxpayers be crushed with a bill that cannot be paid.

This would in turn create another problem, namely the Fed would no longer be able to effectively use interest rates as a tool to combat inflation ala Paul Volcker in the 1980’s. So, no matter how high oil or food prices rise, the American people would be stuck with the low rates — and the resulting inflation.

Previous deviations from sound credit policy contributed to the most recent housing bubble that wrecked the economy, too. But if the country was stuck with super-low interest rates as a new normal, there would be little that could be done about it.

Also consider the disincentive this would create overseas to invest in treasuries and other dollar-denominated assets as long-term investments. Why invest in 10-year treasuries only earning 1 percent if you’re China?

The government and the bank cartel may be betting that trouble overseas, particularly in Europe, will still result in the “flight to safety” by investors into treasuries, even if the Fed is doing much or most of the buying.

Besides, the powers that be could care less who winds up holding the debt, so long as it is bought and maturities are pushed to the out years at low rates.

It can deal with the consequences — i.e. all you little people paying exorbitant prices on commodities, goods, services — later. It can always accuse energy and food producers of “price gouging” or find some other convenient scapegoat to rile the mob up.

And if the worst case scenario occurs, where the dollar loses its status as the world’s reserve currency because we devalued too much, treasuries are dumped globally, the economy crashes, and we experience a spectacular national default — oh well.

Such is the callous disregard the organized banksters, politicians, and faceless bureaucrats really have for the American people who play by the rules, save, and for some reason, may still believe in their nation’s leaders.

Only too late may we realize as a nation the consequences of these insane choices, and how our ability to choose a different path was long ago wrenched from the people’s hands.

Bill Wilson is the President of Americans for Limited Government. You can follow Bill on Twitter at @BillWilsonALG.

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