Towards the end of economic expansions, interest rates usually start to rise as strong loan demand bumps up against central bank tightening.
At first the effect on the broader economy is minimal, so consumers, companies and governments don’t let a slight uptick in financing costs interfere with their borrowing and spending. But eventually rising rates begin to bite and borrowers get skittish, throwing the leverage machine into reverse and producing an equities bear market and Main Street recession.
We are there. After a year of gradual increases, interest rates are finally high enough to start popping bubbles. Consider housing and autos:
Mortgage Rates Up, Affordability Down, Housing Party Over
The past few years’ housing boom has been relatively quiet, but a boom nonetheless. Mortgage rates in the 3% – 4% range made houses widely affordable, so demand exceeded supply and prices rose, eventually surpassing 2006 bubble levels in hot markets like Denver and Seattle.
But this week mortgages hit 5% …
… and people have begun to notice. Here’s an example of the resulting media coverage:
Some of us out there still remember when the average rate on the 30-year fixed mortgage hit 9 percent, but we are not the bulk of today’s buyers. Millennials, now in their prime homebuying years, may be in for the rude awakening that credit isn’t always cheap.
The average rate on the 30-year fixed loan sat just below 4 percent a year ago, after dropping below 3.5 percent in 2016. It just crossed the 5 percent mark, according to Mortgage News Daily. That is the first time in 8 years, and it is poised to move higher. Five percent may still be historically cheap, but higher rates, combined with other challenges facing today’s housing market could cause potential buyers to pull back.
“Five percent is definitely an emotional level inasmuch as it scares prospective buyers about how high rates may continue to go,” said Matthew Graham, chief operating officer of MND.
Home sales have been sliding for much of this year, and total annual sales are expected to come in lower than last year. Affordability is the clear culprit. With rates now more than a full percentage point higher than a year ago, that adds at least $200 more to a monthly mortgage payment for a $300,000 loan. It also knocks some borrowers out of qualification because lenders are strict on how much debt a borrower can carry in relation to his or her income.
Some recent headlines illustrate the sudden shift in housing sentiment:
For autos, it’s the same general story, as low interest rates – in the form of 0% financing and too-good-to-be-true lease terms – produced the highest sales ever in 2016.
But lately a couple of things have happened: Everyone who could possibly qualify for a 7-year car mortgage has done so, depleting the pool of potential buyers. And interest rates have risen enough to make it uneconomic for car companies to keep offering yesterday’s crazy-low rates. From today’s Wall Street Journal:
Car buyers on the hunt for a 0% financing deal are going to have to look harder.
Auto lenders are pulling back on the no-interest financing offers that had become widespread in new-car ads and dealer showrooms for much of this decade. Cheap financing reinvigorated the U.S. auto industry’s sales following the recession, helping to keep monthly payments affordable and draw buyers from the used-car market, where lending rates are usually higher.
But as interest rates rose, the cost of such deals has increased, pinching profits for car makers that finance vehicles through their lending arms and must pay the difference to keep the rate at zero for the customer. With U.S. auto industry sales slowing, car companies are turning to other types of sale incentives, such as cash rebates and discount lease rates, to lure buyers to showrooms, dealers and industry analysts say.
“For a long time, everything was 0%,” said Adam Lee, chairman of Lee Auto Malls, a dealership chain in Maine. At first, buyers could find 0% finance deals on 48-month car loans, and then auto lenders started extending those deals to 60-month loans and eventually 72-month loans, he said. “There are fewer and fewer of those deals now,” Mr. Lee added.
In September, the percentage of new cars financed with an interest rate of 1% or less fell to 5.3% for the month, down from 8.2% in September 2017 and 11.7% in September 2016, the year U.S. auto sales peaked, according to market research firm J.D. Power.
No-interest loans have become even scarcer, accounting for 3.4% of all new-car financing in September, down from 9.1% two years ago, J.D. Power said.
The average financing rate for a new-car purchase was 5.75% in the second quarter, up from 4.82% two years ago when auto sales were at their strongest, according to Experian Automotive.
“You’re definitely seeing the entire industry pulling back,” said Jack Hollis, general manager of Toyota North America, of the scaling back of interest-free auto loans. “Obviously, interest rates rising is a reality in the marketplace, and we’re going to react.”
To sum this up, millions of Americans who were happily signing on the dotted line because of irresistibly cheap financing are done with that kind of thing. The companies selling cars and houses to these people are now desperately trying to cut their expenses to fit their much lower year-ahead sales projections. Those companies’ suppliers are scaling back in response, and so on down the line as two major industries go from boom to bust.
Housing and autos aren’t the only ones hitting a brick wall of higher interest rates. Lots of other businesses depend on their customers’ ability and willingness to borrow. They’ll be the subject of future posts in this series.
This respected analyst is saying we’re likely to see a crisis like we haven’t seen in 50 years, but it’s more likely we’ll see a crisis like never before. Here’s why…
Josh Sigurdson talks with author and economic analyst John Sneisen about the recent warnings by JP Morgan’s top quant (quantitative analyst) Marko Kolanovic who claims we will soon see flash crashes and a great liquidity crisis.
Kolanovic claims that this will likely take place after the first half of 2019, but one cannot really say.
Like in 2010 and in 2018, we will see flash crashes occur he says. The DOW will take a massive hit.
Kolanovic says we will see a crisis the likes of which we haven’t seen in 50 years.
The thing is, we will likely see a crisis like we’ve never before seen in history. With the rate at which it has been propped up, it cannot sustain itself, we’ve seen countless crashes diverted with more centralization/manipulation, the very thing that created the problem in the first place.
The debt levels are enormous, the banking system is collapsing slowly but surely and the bubbles continue to grow throughout the markets based in investor confidence but not fundamental value.
All fiat currencies eventually revert to their true value of zero going back to 1024 AD in China, so there’s no doubt that the central banking system will inevitably come crashing down.
In the end it comes down to individuals sustaining themselves and protecting their purchasing power. Being self sustainable and independent rather than dependent on centralized entities to run their lives. Fonte: qui
10 YEARS AFTER THEFINANCIAL CRISIS
A decade after the collapse of Lehman Brothers, J.P. Morgan takes a look back at the response to the financial crisis that reshaped financial markets and the global economy.
The financial crisis brought the global economy to the brink, with many regarding the bankruptcy of investment bank Lehman Brothers in September 2008 as the seminal moment of the great recession. That same year, the U.S. housing market went under water, J.P. Morgan acquired Bear Stearns in record time as it too faced collapse, stock markets crashed and the Federal Reserve slashed interest rates to their lowest in history. Ten years on, the J.P. Morgan Research team explores what has changed and what the future could hold for the global economy and markets
What’s Changed?
Ten years ago, it wasn’t clear to investors that the worst economic downturn since the Great Depression was on the horizon. Four major long-term forces of globalization, deregulation, innovation and falling volatility had built up since the mid-1980s, ultimately creating a vulnerable system that was hard to detect. So how have things progressed since 2008?
Global Debt has Ballooned
Global sovereign debt has ballooned by 26 percentage points of GDP since 2007. The bulk of the rise is found in developed markets (DM) where debt-to-GDP has surged roughly 41 percentage points —compared to a 12 percentage point rise in emerging markets. With fiscal deficits still relatively elevated, there is no sign that debt levels will be declining in the foreseeable future. The fiscal lending position of DM as a share of GDP fell sharply by more than 8 percentage points to a post-World War II low of nearly -9% in 2009. Despite a substantial decline from its 7.3% peak in 2009, the global fiscal deficit remains elevated at 2.9% of GDP. In the U.S., the fiscal deficit is projected to reach 5.4% of GDP by the end of 2019.
Joseph Lupton, Senior Global Economist, J.P. Morgan
The Housing Bubble
In the years leading up to the crisis, the Fed substantially tightened monetary policy, hiking rates by 425 basis points between 2004-2006. At the same time, mortgage credit growth increased by nearly 45% on U.S. household balance sheets. The securitized products market was booming, particularly non-agency residential mortgages. Issuance rose from $125 billion in 2000 to over $1 trillion per annum in 2005-06. Particular lenders focused on weaker borrowers (subprime and alt-A) and were met with strong investor demand. Government sponsored enterprises Fannie Mae and Freddie Mac bought large volumes of these mortgages from banks and resold them as mortgage-backed securities to investors. This, along with excessive leverage, inadequate lending standards and poor risk controls ultimately led to a collapse of the housing market, the bailout of Fannie Mae and Freddie Mac and the financial crisis of 2008. Today, U.S. consumers are not nearly as exposed to rates as they used to be, with just about 15% of the outstanding mortgage market at an adjustable rate.
Matthew Jozoff, Securitized Products Research, J.P. Morgan
Central Bank Balance Sheets
Over the past decade, major central banks have bought trillions of dollars of bonds to nurse economies back to health. During quantitative easing (QE) the Federal Reserve (Fed) acquired Treasury securities and mortgage-backed securities, with its balance sheet hitting $4.5 trillion at one point. Last year, the Fed started letting some of its bond holdings mature to shrink its portfolio and is currently doing so to the tune of around $40 billion per month. J.P. Morgan Research expects the shrinking of the Fed’s balance sheet to be completed by 2021, with a move down to $3 trillion, but U.S. Treasury holdings will eventually rise above current levels to become the primary asset of their sustained large balance sheet. Outside of the U.S., the European Central Bank balance sheet will start shrinking in 2019, but the Bank of Japan’s balance sheet expansion will likely continue for a while longer.
Jay Barry, Fixed Income Strategy, J.P. Morgan
“Since QE has never been done on this scale and we don’t completely know the myriad effects it has had on asset prices, confidence, capital expenditures and other factors, we cannot possibly know all of the effects of its reversal.
Banks and sovereigns were not the only ones that loaded up on debt in the run up to the crisis; households did too - largely in the form of mortgages. In 2007, U.S. household debt peaked at 1.3 times their personal income, before collapsing during the Great Recession. In dollar terms, U.S. household debt is still climbing. But when factors such as inflation, population growth and income are taken into consideration, the picture looks very different, with the household debt-to-income ratio now 30% lower than its 2007 peak. Debt growth is slower and mortgage delinquencies are at all-time lows too. By contrast, corporations have seen their debt-to-EBITDA ratios increase steadily since the crisis, as issuers have taken advantage of lower interest rates to issue debt.
Matthew Jozoff, Securitized Products Research, J.P. Morgan
Tougher Regulation
In the aftermath of the crisis, international standard-setters introduced bank regulatory frameworks that took a systemic approach to risk. Banks became subject to higher risk-based capital, leverage capital, and liquidity requirements, and tools for resolution were created to protect taxpayers. New institutions were also established beyond the Basel Committee with the creation of the Financial Stability Board. Global regulatory and supervisory frameworks were introduced, such as Dodd Frank and the Comprehensive Capital Analysis and Review (CCAR) to regulate and supervise large banks. In the U.S. and Europe, stress testing requirements were also rolled out. Nearly 10 years on, the Trump administration and Republican lawmakers are now looking to make many post-crisis rules and regulations less onerous, particularly for small and medium-sized banks.
Alex Roever, U.S. Rates Strategy, J.P. Morgan
“Poorly conceived and uncoordinated regulations have damaged our economy, inhibiting growth and jobs. It is appropriate to open up the rulebook in the light of day and rework the rules and regulations that don’t work well.
Since 2008, a substantial amount of healing has taken place, but some legacy costs of the crisis remain. A key concern is the sharp deterioration in long-run growth potential and depressed productivity growth. J.P. Morgan analysis suggests that global potential growth has dropped to 2.7% over the past decade, a decline of 0.3 percentage points from its pace a decade earlier. This decline underestimates the actual damage, as regional drops are far greater. Potential growth in EM, for example, has dropped 1.6 percentage points in the last decade. Global annual productivity growth has also fallen by roughly 1 percentage point since 2012.
Bruce Kasman, Global Head of Economic Research, J.P. Morgan
Looking Ahead
Banks No Longer as Vulnerable
Global banks have faced an unprecedented level of regulatory scrutiny in the aftermath of the crisis and have never been better positioned from a solvency and liquidity perspective going into the next potential recession. “While the ability to foresee the exact sequence of events that could trigger another recession is limited, banks are unlikely to be the Achilles’ heel the next time around.”
Kian Abouhossein, Head of European Banks Research, J.P. Morgan
“We will enter the next crisis with a banking system that is stronger than it has ever been. The trigger to the next crisis will not be the same as the trigger to the last one – but there will be another crisis.
J.P. Morgan Equity Strategy’s end-2018 target is 3,000. Earnings momentum might justify an even higher S&P target, but trade conflict remains an obstacle.
US Stocks Keep Climbing
The S&P 500 peaked at an all-time high in late 2007, before collapsing to hit its financial crisis low in March 2009, sinking to close at 677 - a fall of over 50% from its peak, making it the worst recession fall since World War II. Since then, U.S. equity-market investors have seen huge gains, with stocks hitting fresh all-time highs in 2018, boosted by strong corporate earnings.
Dubravko Lakos-Bujas, Head of U.S. Equity Strategy and Global Quantitative Research, J.P. Morgan
The Rise of Passives
Investors are steadily moving into funds that passively track an index instead of being actively managed by a portfolio manager around this index. In equities alone, some $3.5 trillion of mutual funds are managed on a passive basis globally. In addition, end-investors are steadily moving into exchange traded fund (ETFs), most of which are passive, and which have the added advantage of liquidity. Investors like passive funds as they charge lower fees, create less turnover, and in a number of areas produce better after-fee returns than actively managed funds. However, this shift from active to passive, and specifically the decline in active value investors, reduces the ability of the market to prevent and recover from large drawdowns.
Marko Kolanovic, Global Head of Quantitative and Derivatives Strategy, J.P. Morgan
Total ETF assets hit $5 trillion globally, up from $0.8 trillion in 2008. Indexed funds now account for 35-45% of equity AUM globally.*
While the global bond market has more than doubled to $57 trillion since 2007, liquidity has deteriorated across fixed income markets as banks are playing a lesser role as market makers. Market developments that have taken place since 2008 have led to this severe disruption to liquidity, which could be a key attribute of the next crisis. While gross high-grade bond supply has increased by 50% for the past decade, turnover in the U.S. investment grade corporate bond market is 42% lower and dealer positions for investment grade bonds have fallen by some 75%. This decline in market liquidity alongside the rise in passive investment reduces the ability to prevent large drawdowns in the event of increased market volatility.
Joyce Chang, Global Head of Research, J.P. Morgan
The Perfect Hedge?
Ten-year Treasury yields declined nearly 300 basis points during the last recession and the U.S. Government Bond Index returned 14.3% in 2008, the third-strongest annual performance in history. Overall, heading into the next recession, the Fed will have less room to lower policy rates compared to previous recessions. But if form holds, Treasury yields, particularly on shorter-dated maturities, will decline as the market anticipates the onset of an easing cycle. J.P. Morgan Research expects 10-year Treasury yields to fall by half around the next recession, from a peak of 3.5%.
Jay Barry, U.S. Fixed Income Strategy, J.P. Morgan
We expect 10-year Treasury yields to fall by half around the next recession, from a likely peak of 3.5%.
Lessons Learned
Ten years ago, the financial system was fully exposed. Governments around the world invested taxpayers’ money to save banks from failure, central banks were forced to use unconventional monetary policy to prop up markets and regulators stepped in to try and ensure that a liquidity crisis of that scale could not take place again. Capital and leverage ratios for banks are now significantly stronger and the so-called “too big to fail” global banks have never been better positioned from a solvency and liquidity point of view going into the next potential recession. Banks are also less complex and face harsh stress tests annually to check their ability to withstand severe losses.
Compared to 2008, the U.S. consumer is also in much better shape. The household debt-to-income ratio is down, lending standards are vastly improved and households are not as exposed to rate hikes as they once were. Looking at what could trigger another crisis, most analysts agree that the weaknesses that caused the Great Recession will not be the cause of the next crisis, but other risks have emerged in their place. The rotation from active to passive investment reduces the ability of the market to prevent large drawdowns. The structure of the lending landscape has also transformed, with the share of non-bank U.S. mortgage lending surging to over 80% of the market, from under 20% before the crisis, raising questions about stability. Non-bank lenders are typically less capitalized than banks and there is no mechanism to determine who could take over the servicing role of non-banks if they were to go out of business. And for markets, tail risks are also likely to increase in 2019 as the impact of unprecedented monetary policy retreats.
I’ve written for years that Chinese economic development is partly real and partly smoke and mirrors, and that it’s critical for investors to separate one from the other to make any sense out of China and its impact on the world.
My longest piece on this topic was Chapter Four of my second book, The Death of Money(2014), but I’ve written much else besides, including many articles for my newsletters.
There’s no denying China’s remarkable economic progress over the past thirty years. Hundreds of millions have escaped poverty and found useful employment in manufacturing or services in the major cities.
Infrastructure gains have been historic, including some of the best trains in the world, state-of-the-art transportation hubs, cutting edge telecommunications systems, and a rapidly improving military.
Yet, that’s only half the story.
The other half is pure waste, fraud and theft. About 45% of Chinese GDP is in the category of “investment.” A developed economy GDP such as the U.S. is about 70% consumption and 20% investment.
There’s nothing wrong with 45% investment in a fast-growing developing economy assuming the investment is highly productive and intelligently allocated.
That’s not the case in China. At least half of the investment there is pure waste. It takes the form of “ghost cities” that are fully-built with skyscrapers, apartments, hotels, clubs, and transportation networks – and are completely empty.
This is not just western propaganda; I’ve seen the ghost cities first hand and walked around the empty offices and hotels.
Chinese officials try to defend the ghost cities by claiming they are built for the future. That’s nonsense. Modern construction is impressive, but it’s also high maintenance. Those shiny new buildings require occupants, rents and continual maintenance to remain shiny and functional. The ghost cities will be obsolete long before they are ever occupied.
Other examples of investment waste include over-the-top white elephant public structures such as train stations with marble facades, 128 escalators (mostly empty), 100-foot ceilings, digital advertising and few passengers. The list can be extended to include airports, canals, highways, and ports, some of which are needed and many of which are pure waste.
Communist party leaders endorse these wasteful projects because they have positive effects in terms of job creation, steel fabrication, glass installation, and construction. However, those effects are purely temporary until the project is completed. The costs are paid with borrowed money that can never be repaid.
China might report 6.8% growth in GDP, but when the waste is stripped out the actual growth is closer to 4.5%. Meanwhile, China’s debts grow faster than the economy and its debt-to-GDP ratio is even worse than the U.S.
All of this would be sustainable if China had an unlimited ability to rollover and expand its debt and ample reserves to deal with a banking or liquidity crisis. It doesn’t. China’s financial fragility was revealed during the 2014-2016 partial collapse of its capital account.
China had about $4 trillion in its capital account in early 2014. That amount had fallen to about $3 trillion by late 2016. Much of that collapse was due to capital flight for fear of Chinese devaluation, (which did occur in August 2015 and again in December 2015).
China’s $3 trillion of remaining reserves is not as impressive as it sounds. $1 trillion of that amount is invested in illiquid assets (hedge funds, private equity funds, direct investments, etc.) This is real wealth, but it’s not available on short notice to defend the currency or prop up banks.
Another $1 trillion of Chinese reserves are needed as a precautionary fund to bail-out the Chinese banking system. Many observers are relaxed about the insolvency of Chinese banks because they are confident about China’s ability to rescue them. They may be right about that, but it’s not free. China needs to keep $1 trillion of dry powder to save the banks, so that money’s off the table.
That leaves about $1 trillion of liquid reserves to defend the Chinese currency, if so desired. At the height of the Chinese capital outflows in 2016, China was losing $80 billion per month of hard currency to defend the yuan.
At that tempo, China would have burned through $1 trillion in one year and become insolvent. China did the only feasible thing, which was to close the capital account; (interest rate hikes and further devaluation would have caused other more serious problems).
This distress might have been temporary if China had managed to maintain good trading relations with the U.S. But that proved another chimera. The trade war, which has broken out between the U.S. and China has damaged Chinese exports and raised costs on Chinese imports at exactly the time China was counting on a larger trade surplus to help it finance its mountain of debt.
Now trade is drying up and China is stuck with debt it can’t repay or rollover easily. This marks the end of China’s Cinderella growth story, and the beginning of a period of economic slowdown and potential social unrest.
The coming Chinese crack-up is not just theoretical. The hard data supports the thesis. Here’s a real-time data summary from the Director of Floor Operations at the New York Stock Exchange, Steven “Sarge” Guilfoyle:
The greater threat to financial markets will come, in my opinion from the slowing of global growth, at least partially due to the current state of international trade. This thought process is lent some credence by last night’s rather disastrous across-the-board macroeconomic numbers released by China’s National Bureau of Statistics. … For the Month of July, in China – Fixed Asset Investment.Growth slowed to the slowest pace since this data was first recorded back in 1992, printing in decline for a fifth consecutive month. Industrial Production. Missed expectations for a third consecutive month, while printing at a growth rate equaling the nation’s slowest since February of 2016. Retail Sales. Finally showing a dent in the armor, missed expectation while slowing from the prior month. Unemployment. This item has only been recorded since January. Headline unemployment “popped” up to 5.1% from June’s 4.8%. Oil Production. The NBS reported that Chinese oil production fell 2.6% in July, and now stands from a daily perspective at the lowest level since June of 2011. China will not report Q3 GDP until October 15. The National Bureau of Statistics reported annualized growth of 6.7% for the second quarter. Depending on the veracity of the data, one must start to wonder if China can indeed hang on to growth of 6.5% going forward.
This unpleasant picture Sarge paints is based on official Chinese data. Yet, China has a long history of overstating its data and painting the tape. The reality in China is always worse than the official data reveals.
This slowdown comes just months after Chinese dictator Xi Jinping was offered a dictator-for-life role by the removal of term limits and was placed on the same pedestal as Mao Zedong by the creation of “Xi Jinping Thought” as a formal branch of Chinese Communist ideology.
The Book of Proverbs says, “Pride goeth before destruction, and a haughty spirit before a fall.” Xi Jinping now finds himself in precisely this position. His political ascension inflated his pride just as he now faces the reality of a falling economy and possible destruction of any consensus around his power and the lack of accountability.
Trump continues to tighten the screws with more tariffs, more penalties, and a near complete shutdown of China’s ability to invest in U.S. markets.
Turkey, Argentina, and Venezuela are large developing economies that are in different stages of collapse and threaten the global economy with panic through contagion.
Yet, those three economies combined are not as large or important as China. Only Trump and Xi can salvage the situation with negotiation and reasonable compromise on trade and intellectual property. But, Trump won’t blink first; that’s up to Xi.
So far, a spirit of compromise is not in the air. A spirit of Chinese collapse and contagion is.
“There is a sword of Damocles hanging over the head of every American. Sadly, it is about to drop.”
Sorry for the drama, but I need to get your attention.
We know that the Fed has kept interest rates low for many years until recently. Why did it do so? Here are some of the reasons we have been told:
The Fed wanted to stimulate the economy.
The Fed wanted to make it easier for Americans to borrow.
The Fed wanted to create a “wealth effect” to encourage spending.
Which of these statements do you think explains the primary reason for the Fed’s decision to keep interest rates low? Don’t bother. It is none of the above.
The primary reason the Fed kept interest rates low was to avert an economic catastrophe. Today, that catastrophe can no longer be avoided.
The trigger for the economic explosion is the rising interest payments on the federal debt.
Let’s go through the numbers.
During the eight years of the Obama administration, our total national debt rose from $12.3 trillion to $20 trillion while interest rates sank to a new all-time low. (The national debt figure includes money owed by the government to itself. The debt held by the public is what interests us since the government must pay out the interest to those bond holders.)
In 2009, the year President Obama took office, the national debt held by the public was $7.27 trillion. At the end of fiscal 2016, that had soared to approximately $14 trillion. Given that our marketable debt doubled from 2009 to 2016, it’s remarkable that the annual cost of the interest on the debt rose far less, from $185 billion to $223 billion.
The long march of rising rates that began recently is a dramatic reversal after nearly 40-years of declining interest rates. The new trend portends a return to more historic rates. You may be asking: what are the historic rates? We calculate that the average rate paid on the federal debt over the last 30 years was close to 5%.
The non-partisan Congressional Budget Office (CBO) has just raised its estimate that debt held by the public will rise to $17.8 trillion in 2020. Some economists believe that the figure will be much higher. For our exercise though, let’s stick with the CBO estimate. We are postulating that the interest rate on our national debt may return to the long-term, 30-year average of 5%. Note, too, that Treasury debt rolls over every 3 to 4 years so the maturing bonds at low interest rates will be refinanced at the then current higher rates.
Let’s do the math together.
Take the CBO estimate of debt held by the public of $17.8 trillion in 2020, a 5% average interest on that amount comes to annual debt service of $891 billion, an unfathomable amount. (In 2017, interest on the debt held by the public was $458.5 billion, itself a scary number.) In its current report, the CBO added: “It also reflects significant growth in interest costs, which are projected to grow more quickly than any other major component of the budget.”
Here’s the danger:
According to CBO, individual income taxes produced $1.6 trillion in revenue in fiscal year 2017.
Under this 2020 scenario, over half of all personal income taxes will be required just to service the national debt.
Annual debt service in 2020 will exceed our newly increased defense budget of $700 billion in FY 2018.
Annual debt service would exceed our Social Security obligations.
Note: We are using fiscal year 2017 budget numbers for comparison. It is likely that all the numbers will be higher in 2020, but the proportions will likely be similar or worse.
These numbers are staggering, more so because the assumptions we use are reasonable and predictable. This dangerous trend is the consequence of our failure to pay enough attention to the national debt, and especially to the effect of rising interest rates.
What can we do about this coming crisis? As investors, we should prepare for higher inflation and higher interest rates. Investors should consider these moves:
Sell all medium and long-term bonds.
Consider diversifying into reasonable amounts of gold and selected commodities.
Buy TIPS (Inflation protected treasury bonds).
This last suggestion is an exceptionally interesting investment because these are U.S. Treasury bonds that adjust for inflation by adding to the principal every six months. So long as you buy the bonds at par, you will get all your principal back at maturity, even in the unlikely event we have a long bout of deflation. On the upside, if there is a spike in inflation, these bonds could increase substantially in value, a welcome and unusual occurrence for a bond guaranteed by the U.S. Treasury.
In time, the responsibility for solving the crisis will fall on the Administration and Congress, who have successfully ignored this predictable problem for years.
