Posted by: 2russ | May 13, 2011

The Sky’s the Limit

The Sky is the Limit, when debt is concerned; We have met the enemy, and they are us!

The Romans used to shave their coins and thus monetize their debt, by making more coins from shavings.  They owned the gold and the smelter.

If you could do anything legal to liquidate your debt, would you go for it?  It’s tempting, isn’t it!  Bankruptcy?  Ugly!  Refinance your loans to the lowest possible rate.  The perfect solution!

Debt is a crushing burden.  Individuals can “garage sale”, “Ebay”, or walk away.  But, can governments?  Really?  No, not really!  The moral hazard is too heavy a weight, too unseemly.  But they have their own trick. And it’s a sleight of hand to get out of the burden, the weight.  It is a bit they have mastered from the Roman days:  the liquidation of debt.

  Percent of Implied Inflation over ten and thirty year periods on a per year basis.

Nominal Rate 10 year Treasury 3.125%  Bond rate
10 year TIPS Base Rate 1.125%
10 year implied Inflation rate per year 2.00 %  = rate of inflation
Nominal Rate 30 year Treasury 4.375%  Bond rate
30 year TIPS Base Rate 2.125%
30 year implied Inflation rate per year-over 30 yrs. 2.25 %  = rate of inflation

Treasury Inflation Protected Securities vs. Ten and Thirty year U.S. Treasury Bonds

If you are not earning over 2.25% interest you are receiving a Negative Yield.

If the government can lower the amount they pay for the money lent to them, (i.e. bonds), then their debt to Gross Domestic Product, GDP, is lower.  GDP represents the total of goods and services produced and sold as a sovereign nation.  A lower debt to GDP ratio preserves their AAA credit rating, (if that is what your government has)!

If this hypothetical sovereign runs low on cash, they have to borrow, (or tax).  Borrowing, being the lesser of two evils, they proffer issuance of bonds, hopefully via the full faith and credit of their good name.  They can raise their credit card limit to maintain the borrowing and the servicing of said borrowing – borrowing known to all as debt.

This would be a good plan for the individual, too.  Except for one thing:  No one is giving anyone, anything! Moreover, banks aren’t lending. businesses aren’t hiring, and most of us are de-leveraging, ( think flotsam and jetsam) everywhere.  No one is buying and we are at one another’s throats out of frustration!  Generation-ally we are competitive, (pitting young vs. old), and culturally we are competitive, (race vs. race, gay vs. straight, rich vs. poor, red vs. blue, coffee vs. tea)!

The Paradox of Us and Them

Paradoxically, government – defined as what we all decide to do together and when no one else wants to do it, is giving things away.  There is some health coverage and some food support.  There is very little housing support.  Then of course there is protection. All in all the government is a trustworthy partner, since they are us anyway! We can trust ourselves!  But more on that later….

What to do with Money – If you have any!

Credit card limits are being reduced and some credit cards are refusing customers.  If you had money saved, you are getting a negative real yield.  1/2 of 1 % is less than the 2% inflation, so you are losing 1 1/2 % per year on your money.  So, that doesn’t work.

So what is a country to do?  What is an individual to do? The individual can change course, change lifestyle, cut corners, adapt and invest in different instruments.  The mattress returns even less % than the bank, though.

But for a country:  Security and defense are necessities; the social safety net is a necessity.  The safety net ultimately catches the above unnamed individual who has found them self with no more corners to cut.  And, they have to be protected from the threat of foreign war.  So, for a country, the sky has to be the limit in terms of borrowing.  The credit card limit – the debt ceiling has to be raised! It’s the way to preserve their AAA credit rating.  People feel assured in lending to them, knowing that they will be paid back.  We all live to play another day to use a sports analogy!  Maybe we don’t win today’s game and we get punched and bruised, but we get to play tomorrow.  The sky’s the limit then, and tomorrow is a whole new ball game!  It starts with a flip of a coin.  Hopefully, though, it is not a shaved one!

If you are a conservative bond investor, a bank customer, a money market person, or a Certificate of Deposit person, you may be shaking hands with the government. Make sure that you haven’t signed up for a certificate of confiscation, as the rate of return is reminiscent of a skunk encounter: you get a bad smell not sensed until after you have passed it.

The tricky part is:  How do you balance AAA safety with the spread you need – to keep up with, and surpass inflation?  For that you will need to explore the so called “Safe Spread concept!”

Until then, if you are shaking hands, make sure the other shaker does not have their other hand – in your pocket!

And, if you are shaking hands with yourself, all your pockets are exposed.

2Russ May 2011


Monthly articles on Economics and Finance covering money, investing and trends in the economy!

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