Doylestown Wealth Management - LPL

165 West Ashland Street Doylestown, PA 18901
P: (267) 864 - 2000 | F: (267) 864 - 2010

Monthly Budget Review January 2017

Sometime next month—it would have been in February had the IRS not delayed the refund season–the total federal debt will surpass $20 trillion.  This milestone will be the occasion for a thousand blogposts, news reports, and letters to the editor bemoaning our fiscal profligacy and burden we are bequeathing to our children and grandchildren.  The general tenor will demand that Washington simply must get spending under control.  What if, they will say, you ran your family’s budget the way the government runs its affairs—you would be ruined in no time!

Well, the federal government is not a household—and in monetary matters it is both misleading and counterproductive to act as though it is.  We might with equal accuracy say that if chickens were elephants the henhouse would be too small, or that if the world were flat we could sail off the end.  False analogies lead to faulty conclusions.

This commentary has no wish to bore anyone with a detailed description of the monetary mechanism which makes the federal government unique (although we would be happy to take up the subject with anyone who is interested.) Suffice it to say that the federal government is a currency issuer and not a currency user.  Whether the government (and when I say government here I count the Treasury and Federal Reserve as two faces of the same coin) should issue currency is a matter of policy; whether it can is not in dispute.

Another way of thinking about this “crisis” is to consider not the debt but the debt service—not the amount borrowed but the interest payments due each year.  The principal is not really a concern, since it is denominated in dollars—the very same dollars which can be created by the Federal Reserve at will—as it did (and may do again) during its quantitative easing (QE) programs

In the extreme case, a 0% interest rate would mean the federal debt was be no burden at all.  The only concern then would be whether the old debt coming due could be rolled over, or if new debt could be sold.  In the last extremity the Federal Reserve could step in and issue some of its own 0% interest obligations (we call them dollars) in exchange for the debt.  And if you think that a country can’t maintain a 0% interest rate on its debt, please let the Japanese know—they’ve only been doing it for a decade now.

As you can see in the following graph, the average interest rate on the federal debt has been falling since the early 1980’s as high-interest rate debt matures and is replaced with lower coupon instruments.

This means the effective debt service—the amount of interest the Treasury actually needs to pay out—is essentially the same as in 2000, when the debt held by the public was a quarter of what it is now.

 

This is not to say that there are no drawbacks to the increase in debt.  Because a return to the 4-5% interest rates which were the norm prior to the financial crisis of 2008 would lead to rapidly expanding deficits, the Federal Reserve feels a great deal of pressure to avoid busting the budget with ballooning debt service.  It would seem that we—along with the rest of the world’s developed economies– have painted ourselves into a low-interest rate corner which will require some new ways of thinking about the deficit to escape.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.  All performance referenced is historical and is no guarantee of future results.  

 Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Doylestown Wealth Management, Inc. are separate entities from LPL Financial.