Treasuries Headed For Junk Status?

[Dr Dave]

June 25, 2006
The New York Times
Everybody's Business
Note to the New Treasury Secretary: It's Time to Raise Taxes
By BEN STEIN

Mr. Henry M. Paulson Jr.

The Goldman Sachs Group

New York, N.Y.

Dear Mr. Paulson:

You almost certainly don't remember little me, but I met you many years ago when you worked on what I think was the Domestic Council under the redoubtable John D. Ehrlichman. Even then, you were an intense and clearly brilliant young man. Since then, time has proven you to be a brilliant and intense middle-aged man. To become chairman of an empire like Goldman Sachs is a spectacular achievement by any measure.

But now you have your work cut out for you as Treasury secretary. You are facing what is, in many ways, the most dangerous economic future since the Depression. Danger is coming on many fronts, only dimly seen by the powers that be in Washington, and your insights and eloquence will be urgently necessary.

Just to give you an idea what you are up against, Standard & Poor's issued a warning not long ago. The caution was that if the United States government did not seriously alter fiscal policy, Treasury bonds would be downgraded to BBB, slightly above junk status, by 2020. This is a stunning piece of news for the world's most highly rated security denominated in its primary reserve currency. The S.& P. report said further that if the nation did not make serious changes after that, by 2025 Treasuries would be junk bonds, like the bonds of less successful emerging-markets nations.

These downgrades would occur because the federal budget deficit and the cumulative national debt would be so high relative to the gross domestic product. This debt would presumably come largely from Social Security and Medicare obligations, considered sacred contracts by American taxpayers. (The statement said similar downgrades would also happen to other major countries in the developed world that have large aging populations.)

Just to get an idea of the size of the structural cumulative deficit for Medicare alone, Phil DeMuth, along with others, has calculated that the total Medicare obligations for the balance of this century, if brought down to net present value at the long-term bond rate, would exceed the wealth of the entire nation. This means that if you sold every home, every farm, every factory, every business in America and invested the money in something that returned as much as long-term bonds, there would not be enough to pay for the foreseeable Medicare expenditures of this nation in the 21st century. And that's not counting Social Security or the military or the interest on the debt or the livelihood of 300 million Americans.

Can you imagine, Mr. Paulson, what it will mean to Americans in terms of our currency's value, in terms of the interest we will have to pay to foreign creditors, if our bonds reach junk status? Can you imagine just how crippling a burden this will be on taxpayers?

It gets worse. The annual trade deficit with the rest of the world is approaching $1 trillion. It's not there yet, but we're on our way. This means we have to transfer ownership of roughly $1 trillion of our assets to foreigners every year to cover our excess of international purchases over sales. But the total worth of all the assets in the United States is not greatly more than $50 trillion. To be sure, it rises annually. But even so, we are basically transferring the value of an average of one of our 50 states to foreign investors every year. This trend looks unsustainable to me (unless we are to revert to being a colony — this time, of China).

Again, the downgrades and the deficits in the current account and the federal budget will have major effects on the dollar's value, which will mean major inflationary effects. If experience is any guide, these effects will slow real economic growth.

Right now, inflation is moving out of the Federal Reserve's comfort zone. The Fed chairman, Ben S. Bernanke, is doing the right thing by raising rates and trying to slow the overheated economy, but in a way that does not bring us a recession. To give us a soft landing without recession or stagflation — rising inflation and slow growth, as we had in a good part of the 1970's — is not an easy or assured task.

To raise rates enough to slow down our economy and thus bring down commodity prices amid skyrocketing demand in developing economies is certainly not easy. To do this correctly, you'd need to be a brain surgeon of monetary policy and a cardiac ace of fiscal policy. In other words, there is a great, great deal to be worried about.

May I respectfully suggest that in this environment, ending the estate tax is not a major sensible priority? May I suggest that having the lowest taxes in 65 years on high-income taxpayers is not really as prudent as it might be if we were not running stupendous deficits, with far worse in the future?

I know you are a Republican, and so am I. Now and then, scornful fellow Republicans ask me what kind of Republican I am, since I'm for higher taxes on the rich. I tell them that I am an Eisenhower Republican, the kind who wants to leave a healthier America to posterity. That includes an economy not headed for the status of a banana republic's economy.

Now, I know that a truly great man, Ronald Wilson Reagan, when asked if he were not worried that his tax cuts would burden posterity with a heavy weight, supposedly asked, "What has posterity ever done for me?" Those of us with teenage children certainly know what he meant. But the problem is no longer quite as funny.

The fiscal house is in severe disorder. I love President Bush, and I believe that he wants to do the right thing. I know for sure that Karl Rove is a genius and wants to do the right thing as he sees it (which may well be totally different from how I see it). Mr. Bernanke knows what's right and wrong. You will have allies. But someone needs to take a stand, and that person might as well be you.

The time is always right to do right, and now is a good time to start. This one will make running Goldman Sachs look easy.

Respectfully submitted,

Ben Stein

Ben Stein is a lawyer, writer, actor and economist. E-mail: ebiz@nytimes.com.

-30-

Which leads me to the thought that perhaps the only thing worse than a tax-and-spend liberal is a spend-and-don't-tax "conservative."

[Gordon B]

Dave, 2020 is so far away. Nobody can predict that far ahead. I wonder about Ben Stein because a couple of months ago he wrote a column defending the economic policies of George Bush and he remains staunchly pro-Bush.

[claude]

True enough Gordon, but do you see any substantive problem with this thesis? How do you see the deficit/debt shrinking under the current circumstances? Or, conversly, how do you see the GDP growing sufficiently to cover current spending? Whatever you think of the author, I think there are some serious issues brewing that will affect much more than just the USA.

[Dr Dave]

Originally Posted by Gordon B

Dave, 2020 is so far away. Nobody can predict that far ahead. I wonder about Ben Stein because a couple of months ago he wrote a column defending the economic policies of George Bush and he remains staunchly pro-Bush.

So you're telling me Standard & Poor's just put that advisory out to be cute? A little silly fantasy for us to dismiss out of hand?

Regarding Stein: Lots of people (well, fewer and fewer all the time...) are staunchly pro-Bush but still able to disagree with his "no spending vetos on my watch" policy.

[Gary Sisco]

Truth is, foreign investors, often governments, especially China's, are going to begin buying them less because they're simply going to become less profitable over time, which alone will decide the issue buy or not buy. If they stop buying, bonds will plummet, taxes increase, heavily, no choice. The rest of the world won't continue bailing out American excesses and refusals to fiscally discipline itself forever. No investor would.

[Captain Hate]

Originally Posted by Gary Sisco

Truth is, foreign investors, often governments, especially China's, are going to begin buying them less because they're simply going to become less profitable over time, which alone will decide the issue buy or not buy.

The only way that these are "profitable" to buyers is through buying and reselling; these yield a very low return and their major appeal is in being an incredibly safe place to park money over time without it losing its value. People will continue to do that until they think that somewhere else is safer. Maybe in 20 years there will be a more secure investment but now there's no indication what that would be. I doubt that it will be something based on the Euro.

[Jon Abbey]

what's funny is the only thing keeping them up at all is the massive amounts the Chinese and Japanese governments already own. they need to keep buying them, otherwise their existing portfolios will lose value. it seems inevitable that it will all blow up without some kind of serious intervention like Stein suggests, it's just a question of when.

[Dr Dave]

Originally Posted by Jon Abbey

what's funny is the only thing keeping them up at all is the massive amounts the Chinese and Japanese governments already own. they need to keep buying them, otherwise their existing portfolios will lose value. it seems inevitable that it will all blow up without some kind of serious intervention like Stein suggests, it's just a question of when.

Yes, it's a variation on "When you owe your bank $10,000, you have a problem; when you owe your bank $1,000,000,000,000, your bank has a problem."

[Gary Sisco]

Captain, What is different in your post as opposed to mine. The point is that foreign investors, including foreign states, which buy a huge bulk of such bonds, are not going to buy them when they become less safe an investment. That's all. Period.

When that happens, and it will, because no one in their right minds believes the US Congress is going to all of a sudden change its profligate ways and not pass on to another generation the consequences of its fiscal frivolity, the debt burden will still remain and then some because of interest and profit, and it will have to be paid up -- by Americans. In the form of hugely increased taxes.

Everyone, including the US government, must one day pay the man. No way out.

[Captain Hate]

Originally Posted by Gary Sisco

Captain, What is different in your post as opposed to mine. The point is that foreign investors, including foreign states, which buy a huge bulk of such bonds, are not going to buy them when they become less safe an investment. That's all. Period.

Your initial post mentioned the profitability of T bonds which I thought was somewhat misleading; people don't buy them to get rich (unless they use them for arbitrage), they buy them to stay rich. Your more recent post accents the safety aspect.

While I'm not as nervous as everyone else here seems to be about deficits (they still aren't that much different as a percentage of GDP as they've historically been and the economy is growing) the demographics of Social Security and Medicare don't paint a pretty picture. There's still the matter of where people are going to find a better alternative investment, of which nothing looks all that great to me at this point. Abbey's point of having a captive group of investors is well put, and I don't see a future of highly stuffed mattresses.

[Dr Dave]

Originally Posted by Captain Hate

There's still the matter of where people are going to find a better alternative investment, of which nothing looks all that great to me at this point. Abbey's point of having a captive group of investors is well put, and I don't see a future of highly stuffed mattresses.

You have to admit, hoping our present creditors don't find more attractive investments isn't much of a policy.

[Gary Sisco]

First of all, one has to know what the deficit actually is, Capt, to know what percentage of this or that it might be. The way they've cooked the books, there was an article some years backed where the GAO said it was impossible to determine, actually. You have to know where zero is and they don't.

Even in Clintoid daze, there was never a "surplus" for all the talk of one, since they insisted (still do) on counting social security/medicare revenue as if general revenue when it's not.

The latest figures I've seen that try to account for these criminal (for anyone in private life) accounting tactics placed the deficit this year at around 765 billion dollars. (the Economist) I think that's rather a historical deficit, right there.

There's so much bullshit now I don't think anyone could ever actually sort out the books but I'll tell you what. If people think social security is a mess on demographic projections alone, try adding a slacking off of foreign states' purchasing of bonds to the picture. And who else would they turn to as alternative buyers, when you're talking trillions of dollars? Bill Gates? His fortune's lunch money by comparison.

Profit, yield, safety, whatever. When the bonds come to be seen as no longer sensible, or even less sensible (as they are already beginning to be viewed) for whatever reasons or words we choose, the result will be the same. Less buying of them. Less buying of bonds will mean that the debt gets serviced how? Government obligations to pay will be financed how? By whom? Magic or taxes?

[Gordon B]

Originally Posted by Dr Dave

So you're telling me Standard & Poor's just put that advisory out to be cute? A little silly fantasy for us to dismiss out of hand?

Regarding Stein: Lots of people (well, fewer and fewer all the time...) are staunchly pro-Bush but still able to disagree with his "no spending vetos on my watch" policy.

Stein knows a little about a lot of things, i.e. he's a Jeopardy! type of guy, but doesn't know 1/2 what his father knew about economics.

The US Treasury yield curve is flat. If the risk of US default in 2020 was really high, why would 30 year US govt bonds be yielding 5.25%? That's for 2036!

Stein insists to this day that Nixon was a good President. Nixon's economic record was dismal and it wasn't just bad luck with OPEC, he made harmful interventions in the economy, e.g. wage and price controls, and pressured Fed Chairman Arthur Burns not to clamp down on inflation.

[Gary Sisco]

Everything's groovy, Doc. Don't worry about a thing. All Americans are going to retire to fields of roses, hottubs full of the finest wines, caviar by the dumptruck load, private medical savings accounts in the millions each, a "Britney" in every bedroom, Republithug cops on every corner keeping us all safe and secure (and in line ... whoops, no, wait ...)...

[Vince Kargatis]

Originally Posted by Gordon B

Nixon ... made harmful interventions in the economy, e.g. wage and price controls

He gave us the fucking corn subsidy. Thanks Dick for our high fructose corn syrup.

[Gary Sisco]

Consumer sentiment rose in June
Fri Jun 30, 2006 10:03 AM ET



NEW YORK (Reuters) - U.S. consumer sentiment rose more than expected in June, a report showed on Friday, as consumers' view of both their current and future conditions improved.

The University of Michigan's final reading on consumer sentiment in June was 84.9 up from May's final reading of 79.1, said sources who saw the subscription-only report.

The median forecast of Wall Street economists polled by Reuters was for a reading of 82.5.

The survey's index of current conditions rose to 105.0 in June from 96.1 in May, while consumer expectations rose to 72.0 from 68.2 in May.

Consumer spending accounts for about two-thirds of U.S. economic activity, but in recent years confidence measures have been a weak guide to actual spending.

Consumers' expectations for increased inflation also subsided in June, the report said, according to the sources.

The University of Michigan's final June reading on one-year U.S. inflation expectations was 3.3 percent, down from 4.0 percent in May. Median expectations for inflation over a five-year horizon eased to 2.9 percent from 3.2 percent in May.

*************

What percent of the same consumers does anyone guess can even define inflation?

One of the things that makes for irrational volatility is this moment by moment announcement of this or that. Trends can only be detected over time and people's opinions in surveys like these mean almost nothing, really -- until published. Then the nearly meaningless becomes another stat.

[Gordon B]

Originally Posted by Gary Sisco

What percent of the same consumers does anyone guess can even define inflation?

One of the things that makes for irrational volatility is this moment by moment announcement of this or that. Trends can only be detected over time and people's opinions in surveys like these mean almost nothing, really -- until published. Then the nearly meaningless becomes another stat.

Gary, what are you talking about? Who asked consumers do define inflation?
I didn't know until now that you consider yourself an expert on the meaning of macroeconomic statistics.

Vince, the Nixon-Butz agricultural subsidy system as well as the awful grain deal with the Soviets are indeed good reasons to rate Nixon poorly.

He really was as bad a President as Isiah Thomas is a GM.

[Dr Dave]

Originally Posted by Gordon B

Stein knows a little about a lot of things, i.e. he's a Jeopardy! type of guy, but doesn't know 1/2 what his father knew about economics.

The US Treasury yield curve is flat. If the risk of US default in 2020 was really high, why would 30 year US govt bonds be yielding 5.25%? That's for 2036!

Stein insists to this day that Nixon was a good President. Nixon's economic record was dismal and it wasn't just bad luck with OPEC, he made harmful interventions in the economy, e.g. wage and price controls, and pressured Fed Chairman Arthur Burns not to clamp down on inflation.

My comment was not about Stein. It was about the S&P advisory he quotes. Let's get a little focus, here.

[Gordon B]

Originally Posted by Dr Dave

My comment was not about Stein. It was about the S&P advisory he quotes. Let's get a little focus, here.

as long as it's mutual, i'm game.

If US bonds are in danger of becoming near junk by 2020, why is the 30 year benchmark yield only 5.25%, the same as the overnight Fed Funds rate?

[Dr Dave]

Originally Posted by Gordon B

as long as it's mutual, i'm game.

If US bonds are in danger of becoming near junk by 2020, why is the 30 year benchmark yield only 5.25%, the same as the overnight Fed Funds rate?

Clearly the market doesn't really believe that current policies will continue for the foreseeable future. That's a good thing, one supposes.

[Gary Sisco]

Climbing debt casts doubt on dollar's future
Job No. 1 for new Treasury chief: Avoid a 'hard landing.'
By Mark Trumbull | Staff writer of The Christian Science Monitor

The buck starts here: As Henry Paulson gets ready to take the helm as US Treasury secretary, a single dollar is worth about 116 Japanese yen, 8 Chinese yuan, and 0.79 European euros. Amid predictions that its value could decline by 25 percent or more, where the US currency goes from here will be a major concern of his tenure.

The issue will help shape the direction of US interest rates, the price of goods in stores, and the health of the world economy.

Many economists believe the dollar will decline in value - and needs to decline - rela- tive to other currencies. The reason: The record US trade deficit shows no signs of shrinking on its own accord. The larger it grows, the greater the risk of a "hard landing" for America if other nations become worried about America's ability to repay foreign creditors, who are now lending some $1.6 million per minute to finance overall US spending.

The hard landing scenario, which could spark a global recession, remains a possibility rather than a consensus forecast. But policymakers worldwide, from finance ministers to the International Monetary Fund (IMF), take the threat seriously.

"The thing that's driving the international focus is the concern that the adjustment [in the dollar] could easily be disorderly and really painful," says Charles McMillion, president of MBG Information Services, an economic consulting firm in Washington. "This imbalance will dominate Paulson's and [Federal Reserve Chairman Ben] Bernanke's efforts, for the rest of their terms."

Mr. Paulson, who was confirmed by the Senate last week, is expected to be sworn in any day to a job that includes being official spokesman on the dollar's value.

He comes to the post from the same investment bank - Goldman Sachs - as Robert Rubin, the Treasury secretary known for a "strong dollar" policy during the Clinton presidency.

What's changed is the global economic environment. America's so-called current account - a broad measure of trade and money flows - is running a deficit in the neighborhood of $800 billion annually, four times as big as in 1995, when measured as a share of the US economy.

"We now have record indebtedness with the rest of the world," says Paul Kasriel, an economist at the Northern Trust Corp. in Chicago. "People have to have confidence that you're going to be able to pay them back."

So far, that confidence remains intact, with the dollar as the dominant reserve currency for central banks. It's also simple necessity: Many nations rely heavily on exports to the US.

Many economists see the magnitude of such imbalanced trade as unsustainable in the long run.

In the hard-landing scenario, foreign governments and investors might conclude that so much lending to the US is unwise. They may seek better returns elsewhere, or worry that the US government won't be able to meet its long-term obligations without resorting to an inflationary use of government printing presses.

The result could be a sharp drop in the dollar, an upward spike in the cost of borrowing in the US, and trouble for countries dependent on US trade. That's a recipe for recession.

Yet economists are divided over the best path forward. Some call for a gradual decline in the dollar, managed carefully by the rhetoric and actions of finance ministers and central bankers.

Others say that the danger of imbalances in the global economy has been exaggerated, and that a "managed decline" in the dollar might simply erode the purchasing power of US consumers without fixing the mammoth US trade deficit.

"We've got capital coming into the US because the US has been growing faster than our trading partners. Why is that bad?" asks Michael Darda, chief economist at MKM Partners, an investment firm in Greenwich, CT.

The imbalances in global trade can be dealt with, he says, as export-centered nations develop stronger economies with more growth in consumer spending.

Many economists agree that a change in the currency value, by itself, is not enough.

The IMF, for example, announced in April its intent to work with several nations, including China and the US, on how to reduce imbalances.

Asian currencies may need to rise. But many see the problem as partly home grown in America, where both households and the government are net borrowers of capital.

A decline in the dollar, they say, coupled with belt-tightening by consumers and the federal government, could put the US on a sounder footing and ratchet the trade deficit down.

Harvard University economist Martin Feldstein calls this a policy of a "strong dollar at home" and a "competitive dollar abroad."

In the 1980s, for example, a falling dollar helped the US export more goods, while the rising cost of imports did not spark inflationary pressure at home. But being both "strong" at home (protecting consumer purchasing power) and "competitive" abroad (boosting US exports) could be tricky.

"The US over the next 10 or 15 years is going to be exporting a lot more and importing a lot less," says Dr. Kasriel at Northern Trust. That might not be as good as it sounds, he warns. "What it really means," he says, "is we're going to be working harder and enjoying it less."

**************************

There is a missing piece in the logic above. If exporting countries (China, for the largest example) develop a larger consumer economy as a biproduct of industrialization, which of course they will over time, it does not in any way necessarily follow that those consumers would be turning to American-exported products. For one thing, there aren't all that many personal-consumption-type products made in the US to export. For another, the exporting countries *do* manufacture many, indeed, most such products, much more cheaply than the US does. One would assume that a goodly part of the new consumer purchasing power of people in growing economies would be spent therefore on those products. Therefore, growth of a consumer economy in countries exporting today to the US does not at all necessarily indicate that in future such populations will be buying products exported from the US, which means that this obvious expectation (such consumer economies will grow in those countries, inevitably) does not in any way have to change the US's trade imbalance back toward the black (a *long* way back toward the black, at a million and a half bucks of deficit per minute).

One might argue, But the exports might be more like service products -- knowledge and so forth, technological knowhow, and etc. But this would not be the case either necessarily -- far from necessarily -- as the US corporations (I used the word facetiously because being transnational, they are not "American" corporations -- they have no nationality) have been and continue at an increasing pace "outsourcing" such jobs *along with* manufacturing jobs. Therefore, many of these "new economy" type jobs will go to non-Americans and therefore do nothing much to alter the US's imbalance or its domestic economy, either.