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DANGER AHEAD FOR U.S. GOVT: Unable To Service Debt As Interest Rates Surge

The U.S. Government is in serious trouble when interest rates rise.  As interest rates rise, so will the amount of money the U.S. Government will have to pay out to service its rapidly rising debt.  Unfortunately, interest rates don’t have to increase all that much for the government’s interest expense to double. 

According to the TreasuryDirect.gov website, which came back online after being down for nearly a month, reported that the average interest rate paid on U.S. Treasury Securities increased from 2.2% in November 2016 to 2.3% in December 2017.  While this does not seem like a significant change, every increase of 0.1% in the average interest rate, the U.S. Government has to pay an additional $20.5 billion in interest expense (based on the $20.5 trillion in total U.S. debt) 

Unfortunately, when interest rates move back toward a more normal rate of 5%, the U.S. Government will have to fork out $1 trillion-plus a year, just to service its total debt.  Even though the Federal Reserve might try to lower interest rates during the next market crash, the market will likely react in the opposite direction as real rates start to rise. 

I will be providing an update on the madness taking place in our economy and financial system in my newest YouTube video Stock Market Leverage & Insanity Reaching Nose-Bleed Levels, which will be out tomorrow.

SRSrocco thinking is along the line as DYI is for a deflationary economic smash causing a depression.  Of course the Federal Reserve will proceed to QE infinite along with a new twist of direct money creation straight to the Treasury Department all with the full premeditated intention of generating inflation  along with the Federal government “priming the pump” with all types of Federal programs.

How to I know with such certainty this will be their game plan.  Except for direct payments from the Federal Reserve to the Treasury this has all been done before.       

The Great Inflation and its Aftermath (2008) by Robert J. Samuelson describes the beginning inflation of the 1950’s, growing inflation of the 1960’s, then the 1970’s inflationary juggernaut inflating GDP thus reducing significantly America’s debt to GDP under 30% from a WWII high of 120%!  Yes budgets were managed more properly but make no mistake through the power of money printing the Fed’s burned off the majority of the debt through inflation.  Of course as usual the middle class and poor took the blunt and especially those who were retired on a fixed income during that time period.

The late Harry Browne [1933 – 2006] money manager/investment newsletter writer became stymied as many other money mangers were; frustrated by the growing levels of inflation, thus reducing and many times completely negating returns on an after inflationary basis.  Harry was the first to originate the concept of uncorrelated assets.  Today the concept is taken for granted but at his time earth shattering placing him #2 next to the late Benjamin Graham [my blog; my opinion] number #3 is Warren Buffet #4 the late John Templeton all others after that are a far distanced #5!

However, as much as I admired Harry’s concept as a value player inspired by the works of Benjamin Graham, Warren Buffet and John Templeton holding 25% at all times – stocks, long term bonds, gold, and cash simply made my hair to catch on fire spontaneously!

You can measure with a degree of reasonableness the level of under or overvalued any asset category based upon their historical average.  This is what created my Value Driven Variable Portfolio an offshoot to Harry’s Permanent Portfolio.

My starting point is that if all three, stocks, long term bonds, gold – cash is my default position – are at their respective mean then each asset will be 25% each.  As we know these totally dissimilar assets are either pushed up or pulled down in price by different economic forces.

Four Uncorrelated Assets

1.)  Stocks

2.)  Long Term High Grade Corporate/Government Bonds

3.)  Short Term Notes (Cash)

4.)  Gold – Precious Metals Mining Companies

Four Assets Correlated to Four Economic Conditions

1.)  Prosperity

2.)  Deflation

3.)  Recession

4.)  Inflation

1.)  Prosperity: Stocks become a clear winner during conditions of increasing employment, rising wages tied to increasing productivity along with rising profits.  Junk bonds (they trade like stocks) are also winners in this environment despite their low quality; the economy is so good interest and principal payments are made – defaults are minimum – and a positive climate for refinancing.  High quality corporate/ government bonds are secondary winners as prosperity is noted for stable or slowly declining rates.  Gold is generally a loser in prosperity as inflation is minimized and investors seek higher returns in more traditional investments.

2.)  Deflation:  Deflation is the decease in the general price level of goods and services.  The Great Depression is a standout example of deflation.  The general cause is when excess debt is built up in the private sector that can no longer be increased and/or maintained resulting in massive bankruptcies.  This creates an environment of panic as businesses scramble to become profitable by firing employees and cutting hours of remaining workers.  In this deflationary episode interest rates decline, prices decline, and the almighty buck rises in value against softer currencies.

Long term high quality corporate bonds and long term U.S. government bonds are winners in this type of economy.  Stocks, gold, and junk bonds generally will fall in price along with interest rates on short term notes.

3.)  Recession:  For DYI's purposes recessions are a period of increasing interest rates engineered by the Federal Reserve in order to quell inflation by slowing down an over heating economy.  This condition is temporary as the economy will either adjust to the new economic environment bringing back prosperity or a deflationary period will begin.

High quality corporate/government bonds, stocks, gold, and junk bonds are all losers in this scenario. Short term notes and money market funds are clear winner as their principal value remains steady plus the interest income improves with increasing interest rates.

4.)  Inflation:  Too much money chasing too few goods.  When Federal government liabilities become onerous from financing of war(s) and/or social programs that are too great to be paid by taxation governments will resort to money creation to pay the remaining costs.  After WWII, Korea, Vietnam and the war on Poverty inflation began slowly prices increased relentlessly (despite high taxes) as government liabilities expanded.  When President Richard Nixon closed the gold window (1971) the last vestige of inflationary controls were removed with inflation peaking in the high teens only until Paul Volker was appointed as Fed Chairman (August 79) who crushed inflation with high interest rates.

Stocks, high quality long term corporate/government bonds, junk bonds are all losers as inflation soars along with interest rate increases (despite the Fed's efforts to suppress them).  Cash (money market funds) or short term notes are neutral or slightly lag inflation rolling up to the higher interest rate quickly.

Gold is a winner when inflation breaks above 5%.  When inflation goes double digit gold is marked up in price to reflect the debasement of the currency.  Gold will also rise in price based upon fear of massive defaults as gold has no counter party risk.

What my concern was the top 20% and the bottom 20% of any of these three assets.  Think of the say stocks from peak to trough as 100% my concern was reducing significantly less than 25% during that top 20% [ or going to 0% in insane markets] and conversely the bottom 20% having significantly greater than 25% due to deep value bargains.  The middle 60% cut in half is the mean.  In the classic sense prices above are overvalued thus need to be reduced and prices below of course need to be increased.  My formula does exactly that and without emotion.  Simply put this is nothing more than a compounding machine; greater the dividend yield for stocks, the formula increases your holdings, same for bonds, and on a valuation basis for gold [precious metals mining companies].

DYI’s first goal is to out perform Harry’s permanent portfolio by at least 100% - that is the real return [after fees & inflation] averaging around 4% per year pushing the Value Driven Variable Portfolio to 8%.  Then lastly, to tie the long term return for the S&P 500; of meaningful importance achieved with significantly less volatility.  Many investors – who think of themselves as long term players – have been chased out of the market during a significant downturn; selling out at the bottom!

 Cheers!

DYI