I begin with a chart. This tracks the yield curve for U.S. Treasury debt. The curve is the interest rate that investors are paid to turn their money over the the Treasury, meaning to Congress.
This curve looks very steep. It is very steep. But take a closer look at it. The top rate is just above 3%. This is for 30-year T-bonds. This means that investors trust the U.S. Congress to to the right thing for the next 30 years. A net return of 3% (before taxes) for 30 years is seen as a wise investment. After federal taxes, top-bracket investors will receive 1.8% on their money — less, if we factor in state income taxes. This assumes that Congress will not raise taxes.
This means that the smartest investors on earth think that the best deal they can get on their money is 1.8%, denominated in U.S. dollars. But if long-term rates rise, they will suffer capital losses. The market value of T-bonds moves inversely to the movement of long-term rates. Today, long-term T-bond rates are at their lowest in post-War history. Problem: price inflation will raise long-term rates, because investors will demand higher rates to protect them from a more rapidly depreciating dollar. So, the banking system must not inflate for the next 30 years.
Are you with me so far? So far, how likely does this scenario strike you?
If you turn your money over to Congress for a year, you will be paid a tenth of a percent, which is taxable at the rate applied to regular income. Top bracket investors will pay 39%. Those turning their money over for 90 days will receive 0.03% before taxes.
Now let’s look at price inflation. This table is published monthly by the Federal Reserve Bank of Cleveland. I use the Median CPI, which is more stable, month to month, than the CPI.
So, anyone who has lent money to Congress over the last 12 months has suffered about a 2.2% loss of wealth. There is little likelihood that price increases over the next 12 months will be zero. Figure at least a 1.3% increase. So, in order to be paid (taxable) a tenth of a percent — far less, if they lend in 90-day-intervals — investors will lose 1.3% on this investment.
We are told that this economy is in recovery mode. This recovery rests on an assumption: American investors will continue to roll over the federal government’s debt of about $12.8 trillion.
Why will investors continue to give away their wealth to Congress on a permanent basis? Because, we are told, U.S. Treasury debt is the closest thing to zero-risk debt on earth. Treasury debt means IOU’s issued by Congress.
Congress. Zero risk. Same sentence.
Debt held by the public includes debt held by the Federal Reserve System.
On October 29, 2014, the Federal Reserve announced that it will no longer buy any new debt. Quantitative easing has ended for now.
Meaning: from now on, investors outside the U.S. government must pick up the slack. They must intervene to donate wealth to Congress on a permanent basis, so that Treasury interest rates do not rise.
Congress needs the money, it says. It does not want to pay positive real interest rates — after-inflation rates. It relies on these donations. It expects to receive these donations. After all, it has been given these donations for several years. Why should Congress expect anything different? Investors are charitable.
Charitable investors. Does this make sense? No. Then why do they do this?
I offer this suggestion: they do not think the economic recovery is sustainable. So, they hedge their bets. They donate wealth to Congress in the short run to protect themselves from Congress in the short run. Why? Because they do not trust Congress in the long run.
This is the new normal.
This is Keynesianism in 2014.
Congress expects this to become the normal normal from now on. It does not expect investors ever to seek a positive rate of return on the money they lend to Congress.
So far, Congress has been correct. We will now find out how long the new normal will last.
