Wiggling Interest

Governmental debt is consuming massive amounts of global borrowing capacity, and tightened governmental regulation is effectively keeping the consumer and business credit markets in an icy if not frozen condition. The February 18^th theDeal.com noted: “The 20 largest recipients of capital from the Treasury's Troubled Asset Relief Program reported modestly declining total loan balances during the last three months of 2008. The median percent change in residential mortgage balances was down 1%… In the first of a new monthly bank lending survey, the Treasury Department said total residential mortgage balances remained ‘essentially flat.’ Corporate loan balances decreased slightly while new commitments for commercial real estate lending decreased 19%. Renewals for existing commercial real estate accounts increased as did credit card borrowing. Overall credit availability for cardholders decreased, Treasury said.”

As the senior financial ministers and secretaries met recently in Rome to decide the level of joint cooperation and policy-making aimed at fighting this managed depression, signs of the next economic crisis, particularly the United States, are settling into the markets. Even after a very-distant recovery shows the slightest indication of beginning, and I think we are a couple of years away from even that slight nudge (even though we will bottom out much sooner), with so much pent up and growing demand for credit in the system, there are existing undercurrents that portend the next fear.

The culprit? Rising interest rates. At some time in the future, relative currency values are going to be much more reflective of a combined examination of aggregate individual, corporate and governmental debt reduced by measurable increases in average per capita productivity – for those nations with scarce or valuable resources, natural or otherwise, that factor will be considered too. In short, in relative terms, how much we owe versus our ability to service the debt and pay down the loan.

If we don’t play this game right, by using our massive borrowings to fix this economy significantly to increase our productivity (education and training with newer, more productive tools and equipment, reducing waste and obvious costs like expensive power consumption – building new industries with new technologies along the way), the fact that we may have created more debt than our neighbors will only result in the devaluation of our currency relative to those nations that borrowed less and/or increased productivity more.

And if our currency depreciates, even after a recovery has begun, global commodities will take more dollars to buy them – basically stuff will cost more. We call that “inflation.”The Federal Reserve reacts to inflation by raising interest rates, making borrowing increasingly expensive, which is supposed to slow spending and shore up the currency. In the late 1970s and early 1980, even mortgage interest rates were in the high teen percentages. We could get there again.

The nascent signs of increasing interest rates reflect that we have to fund our increasing national debt, rising by trillions of dollars to fund one or more stimulus packages, by floating treasury bonds into the global market. Short-term treasuries are/were yielding, effectively, a zero rate of return, but now the government has to find buyers for our governmental debt instruments in an environment where many other governments are following the same path. At the moment, that means we have to pay a higher rate of interest to attract those buyers, normally with T-bills with longer maturity dates, even as the Federal Reserve discount rate (best rate paid to the best banks) hovers around zero.

Foreign buyers still think the U.S. is a safer bet than many of the alternatives. Mexico was forced to withdraw its offering of 21-year-maturity bonds when it was clear there was no real interest in that Mexican paper (and remember, if Mexico destabilizes, they are our most immediate neighbor in the south – it will impact us). But the U.S. only placed its 30-year bond into the marketplace with a 3.54% (actually down from 3.7% earlier); ten year notes were auctioned at 2.82% and three year notes generated 1.42%.

As the U.S. continues to float increasing levels of government debt, the auction market could pressure us to pay increasing levels of interest. Countries like China, usually one of our best debt customers, itself faces the implementation of a $600 billion stimulus package. We simply have to make U.S. treasuries more attractive than those of our competitors, a task that becomes increasingly difficult if the relative value of the dollar begins to fall for the reasons discussed above.

Every economic action produces a set of economic reactions, and that “forever” changing set of variable requires a government to bob and weave in an effort to produce stability within a vector of at least some level of sustainable growth. Those monetary and fiscal policies, combined with how we regulate finance and commerce, will determine how the next generations live… and how much we may have to ask them to reduce their standard of living.

I’m Peter Dekom, and I approve this message.