How Bad Is America’s Debt Really?
Debts are constantly growing. Now, famous big investors are no longer buying U.S. bonds. The fiasco is threatening savers worldwide.
That’s not to say that the United States is not saving at all. In Los Angeles, there is an average of 43 children in English and mathematics classes in the final year of high school. In Detroit, the “Motor City” in the state of Michigan, they are discussing increasing the class sizes to 60 in public schools. However, such measures — albeit drastic — are ultimately only isolated steps. They hardly affect the bigger picture; they do not change anything. America's tower of debt is growing steadily, and now, for the first time ever, it is starting to sway.
Bill Gross, who runs Pimco Total Return Fund and who is also known as the "Bond King," has become famous in the last week for allegedly reducing the fund's holdings in U.S. bonds to zero. Jim Rogers, the legendary hedge fund manager, also thinks it is absurd to invest in bonds. Even Warren Buffet, another investment guru, may no longer get involved in long-term U.S. bonds and is reinvesting in shorter-term ones. In short, the investment world mistrusts America. It frightens professional financial managers when they look at the country's huge liabilities. More and more people realize that this cannot be good in the long run. The only possible solutions seem to be inflation or a shortfall in payment. Both would have unimaginable consequences for savers and investors, not only in the USA, but also here in Germany.
This growing fear is new; having said that, the trend toward increasing debt on the other side of the Atlantic is old. Since the beginning of the '90s, the mountain of debt has been growing faster and faster. The U.S. owes the world almost $14 trillion, the equivalent of $2,000 per Earth dweller, whether young or old, rich or poor. However, the Chinese and Japanese own the largest amounts of debt, and now they are starting to have doubts, too. Even the most enthusiastic buyers of U.S. bonds are becoming increasingly uneasy. Yu Yongding, a former member of the monetary policy committee of the People’s Bank of China, is convinced that if the United States was a member of the eurozone, it would have been declared bankrupt long ago, or saved by another eurozone country. He thus advises China to "stop further building positions."
The Mountain of Debt Is Not Getting Smaller
In this instance, what makes most people uneasy is not even the absolute amount of debt. What is worse still is that there are no signs of the United States being willing to reduce this sum in the near future. "Unlike Europe, the U.S. still does not have a concrete funding plan," said Alexander Koch, an economist from Unicredit, a banking organization based in Italy. The state has recently raised expenditures so high that it has since paid out more on transfer fees than it receives from taxes and contributions. On top of this, there are also the remaining expenditures: from investments, to state workers' salaries to the overblown military budget.
It begs the question of why, with all of this mistrust, the rate of return for U.S. government bonds with a 10-year maturity is valued at just about 3.4 percent and not at 12.8 percent, like Greece's. The answer is really simple: Bill Gross reckons that in the past few months the Federal Reserve, the U.S. central banking system, has purchased around 70 percent of all newly issued bonds. At the beginning of November it announced that it would do exactly that, up to the sum of $600 billion. The central banking system is therefore supporting demand and keeping the rate of return low.
However, at the end of June, this program will end. By the time this happens, at the latest, Gross, amongst others, are expecting the rate of return to rise dramatically. That is also the reason why they are staying away from bonds at the moment: If the rate of return rises, the bond prices will sink. If this happens, Gross and company can buy up the U.S. bonds at a bargain price in a few months' time. And now, by publicly stirring up opinion against U.S. finances, they are trying to force the prices down. So they are having a race. But by doing so, in the end they may realize that they have made a mistake. This is because the Fed has a crystal clear aim: The rate of return must remain low. Otherwise, the economic upturn could be at risk. Hence, from summer, if more private investors do not decrease government debt to keep the rate of return low, the Fed ought to be ready to simply enlarge and extend the bond purchase program once again.
There are several positive aspects of this occurrence, as U.S. citizens simply have no savings that they could invest in the national debt. Contrary to popular belief, the Americans are just as poor as their country. Only around 62 percent of their consumer spending is paid for by wages and salaries. Thirty years ago this figure was still 80 percent. Nowadays in Germany it is still at least 71 percent. The rest is covered by state transfer payments, returns on capital, or by loans. All of these aspects create a perfect vicious circle: If the state saves, people have less money and consume less, so the economy caves in. If people save more, and thus finance the national debt, then the same thing happens. The only way to solve this would be if nobody saved and money simply continued to be printed. But what happens then?
The Next Crisis Is Coming
"In the short term, this ’strategy’ will indeed support growth and the financial markets," Alexander Koch believes. But he also believes that in the mid- and long-term, the next crisis is already looming. "The necessary reforms and changes in behavior are being delayed with such a stubborn attitude, which makes it just as astounding as it is dangerous." It remains to be seen how this will turn out, whether there is a new banking crisis to come, the United States does not end up catching up with their payment obligations or the debts are spirited away by inflation. However, for savers, all variations would be a fiasco, whether in America or here in Germany.
Thus, people have been turning to gold for a long time. As a result, the price per ounce of fine gold recently reached a new all-time high of $1,443. Other people are increasingly investing their money in stocks, because this also concerns real value. In the case of an inflationary trend, they would still make a profit, and in case the United States does still get its act together, the company's investments still belong to the winners.
Conversely, the most unsecured investment may still be government debt. This is a huge transformation, because for decades it was considered to be a safe haven. It is not anymore, at least when it comes to stocks from the United States or other debtor nations. Several of these nations will once again be the focus of the financial market in the next few days, if the European Union heads of state cannot agree on emergency reforms for the euro. Even the U.S. Department of the Treasury will be intently following this story, because as long as Greece, Ireland and other countries are the focus of people's attention, at least it will take people's minds off how the American mountain of debt continues to grow.
That’s not to say that the United States is not saving at all. In Los Angeles, there is an average of 43 children in English and mathematics classes in the final year of high school. In Detroit, the “Motor City” in the state of Michigan, they are discussing increasing the class sizes to 60 in public schools. However, such measures — albeit drastic — are ultimately only isolated steps. They hardly affect the bigger picture; they do not change anything. America's tower of debt is growing steadily, and now, for the first time ever, it is starting to sway.
Bill Gross, who runs Pimco Total Return Fund and who is also known as the "Bond King," has become famous in the last week for allegedly reducing the fund's holdings in U.S. bonds to zero. Jim Rogers, the legendary hedge fund manager, also thinks it is absurd to invest in bonds. Even Warren Buffet, another investment guru, may no longer get involved in long-term U.S. bonds and is reinvesting in shorter-term ones. In short, the investment world mistrusts America. It frightens professional financial managers when they look at the country's huge liabilities. More and more people realize that this cannot be good in the long run. The only possible solutions seem to be inflation or a shortfall in payment. Both would have unimaginable consequences for savers and investors, not only in the USA, but also here in Germany.
This growing fear is new; having said that, the trend toward increasing debt on the other side of the Atlantic is old. Since the beginning of the '90s, the mountain of debt has been growing faster and faster. The U.S. owes the world almost $14 trillion, the equivalent of $2,000 per Earth dweller, whether young or old, rich or poor. However, the Chinese and Japanese own the largest amounts of debt, and now they are starting to have doubts, too. Even the most enthusiastic buyers of U.S. bonds are becoming increasingly uneasy. Yu Yongding, a former member of the monetary policy committee of the People’s Bank of China, is convinced that if the United States was a member of the eurozone, it would have been declared bankrupt long ago, or saved by another eurozone country. He thus advises China to "stop further building positions."
The Mountain of Debt Is Not Getting Smaller
In this instance, what makes most people uneasy is not even the absolute amount of debt. What is worse still is that there are no signs of the United States being willing to reduce this sum in the near future. "Unlike Europe, the U.S. still does not have a concrete funding plan," said Alexander Koch, an economist from Unicredit, a banking organization based in Italy. The state has recently raised expenditures so high that it has since paid out more on transfer fees than it receives from taxes and contributions. On top of this, there are also the remaining expenditures: from investments, to state workers' salaries to the overblown military budget.
It begs the question of why, with all of this mistrust, the rate of return for U.S. government bonds with a 10-year maturity is valued at just about 3.4 percent and not at 12.8 percent, like Greece's. The answer is really simple: Bill Gross reckons that in the past few months the Federal Reserve, the U.S. central banking system, has purchased around 70 percent of all newly issued bonds. At the beginning of November it announced that it would do exactly that, up to the sum of $600 billion. The central banking system is therefore supporting demand and keeping the rate of return low.
However, at the end of June, this program will end. By the time this happens, at the latest, Gross, amongst others, are expecting the rate of return to rise dramatically. That is also the reason why they are staying away from bonds at the moment: If the rate of return rises, the bond prices will sink. If this happens, Gross and company can buy up the U.S. bonds at a bargain price in a few months' time. And now, by publicly stirring up opinion against U.S. finances, they are trying to force the prices down. So they are having a race. But by doing so, in the end they may realize that they have made a mistake. This is because the Fed has a crystal clear aim: The rate of return must remain low. Otherwise, the economic upturn could be at risk. Hence, from summer, if more private investors do not decrease government debt to keep the rate of return low, the Fed ought to be ready to simply enlarge and extend the bond purchase program once again.
There are several positive aspects of this occurrence, as U.S. citizens simply have no savings that they could invest in the national debt. Contrary to popular belief, the Americans are just as poor as their country. Only around 62 percent of their consumer spending is paid for by wages and salaries. Thirty years ago this figure was still 80 percent. Nowadays in Germany it is still at least 71 percent. The rest is covered by state transfer payments, returns on capital, or by loans. All of these aspects create a perfect vicious circle: If the state saves, people have less money and consume less, so the economy caves in. If people save more, and thus finance the national debt, then the same thing happens. The only way to solve this would be if nobody saved and money simply continued to be printed. But what happens then?
The Next Crisis Is Coming
"In the short term, this ’strategy’ will indeed support growth and the financial markets," Alexander Koch believes. But he also believes that in the mid- and long-term, the next crisis is already looming. "The necessary reforms and changes in behavior are being delayed with such a stubborn attitude, which makes it just as astounding as it is dangerous." It remains to be seen how this will turn out, whether there is a new banking crisis to come, the United States does not end up catching up with their payment obligations or the debts are spirited away by inflation. However, for savers, all variations would be a fiasco, whether in America or here in Germany.
Thus, people have been turning to gold for a long time. As a result, the price per ounce of fine gold recently reached a new all-time high of $1,443. Other people are increasingly investing their money in stocks, because this also concerns real value. In the case of an inflationary trend, they would still make a profit, and in case the United States does still get its act together, the company's investments still belong to the winners.
Conversely, the most unsecured investment may still be government debt. This is a huge transformation, because for decades it was considered to be a safe haven. It is not anymore, at least when it comes to stocks from the United States or other debtor nations. Several of these nations will once again be the focus of the financial market in the next few days, if the European Union heads of state cannot agree on emergency reforms for the euro. Even the U.S. Department of the Treasury will be intently following this story, because as long as Greece, Ireland and other countries are the focus of people's attention, at least it will take people's minds off how the American mountain of debt continues to grow.