The news last week and for the next few weeks is the negotiations to raise the 2011 US Debt Ceiling and avoid a "Crisis". At the end is an except from Wikipedia on this crisis for your reading pleasure. The first paragraph is a weekly recap from Vanguard. In the middle is my view on how to invest during this historic time period. My view is that this is like a yellow jacket sting that I got today, painful for the next little while and in the longer term probably not that significant of an issue.
Vanguard
Producer and consumer prices both fell substantially in June while sales output and inventory reports continue to point to an economic soft patch. For the week ended July 15, the S&P 500 Index declined 2.1% to 1,316.14 (for a year-to-date total return, including price change plus dividends, of about 5.7%). The yield on the 10-year U.S. Treasury note fell 9 basis points to 2.94% (for a year-to-date decrease of 36 basis points).
Investing and the US Debt Ceiling
This is a historic time period for our country and quite frankly I do not know of anyone who has the correct answer on the path forward out of this mess. We are talking about raising the debt ceiling to a level above the annual Gross Domestic Product (GDP) of our country, this has not been done before. So no magic roadmap exists from here. I will avoid adding to the list of experts my opinion and stick to investing. The most important person in the US right now is the Treasury Secretary who controls this massive amount of debt.
For an investor the key indicator to watch is long term interest rates, in particular the 10 year US Treasury Bond. You notice that last week the yield on the 10 year bond went down 0.09% to 2.94%. We have 3 possible outcomes to this crisis: default, a slowing economy, or no impact. If a concern exists of default on bonds then interest rates should be rising. If the concern is a slowing economy due to less Federal spending then interest rates should be falling. If the crisis is resolved on time then it should have no impact. The falling interest rate last week shows that the majority of investors are not concerned about a default and view it as shelter in the time of a storm, curious.
My view is that nobody wants a default, this is like dropping a huge bomb on ourselves. If we default, then the amount of interest payments on the debt rise and the cost to make the interest payment goes up causing a bigger hole. If interest rates go up 1% it costs us about $150 Billion more a year, as we actually have about $14.6 Trillion in debt at this point.
If an investor thinks that a default is coming then they should sell all US Treasury Bonds now. The question is where will the money go; will it go to cash like a money market, stocks, or commodities? Remember that stocks do well as interest rates go up. My view is that the money goes into either stocks or cash.
If an investor thinks that a slow economy is coming then they should hold US Treasury Bonds now. At the current interest rate, I do not see interest rates going much lower.
At the end this crisis, whenever this occurs, we know it is good for the news media. For a long term investor, I do not think it is a crisis at all since the thing that really matters is long term growth of the economy not this short term panic. For a short term investor this is a really big deal as nobody knows how it will end. If you are nervous about this issue you should call me to discuss how to proceed.
2011 US Debt Ceiling Crisis (From Wikipedia)
The 2011 US debt ceiling crisis is the ongoing debate over whether the debt ceiling should be increased and, if so, by how much. Rather than pass a stop-gap measure that would fund the government without solving the structural problems ("kicking the can down the road"), the leadership of both parties decided to address these budgetary problems as part of this debate. The Democrats in the US Congress and the President wanted the decrease in the deficit to be funded by a combination of spending and revenue adjustments. The Republicans held the view that the deficit reduction should be based solely on spending.
As of July 2011, the United States was effectively at the limit of Congressionally authorized debt. Congress is now considering whether and by how much to extend the debt ceiling. An issue of note is that failure to extend the limit may leave the federal government unable to pay all its obligations, including paying interest on existing debt, a default that could have serious repercussions.
In a May 16, 2011 letter to Congress, U.S. Treasury Secretary Timothy Geithner declared a “debt issuance suspension period,” which provides the Secretary authority to sell assets from the Civil Service Retirement and Disability Fund. Geithner had previously sent letters to Congress requesting an increase in the debt ceiling on January 6, April 4, and May 2, 2011.
When the debt ceiling is reached, the U.S. Treasury has methods to acquire funds other than issuing new debt to meet federal obligations. Several of these methods are described in detail in an Appendix attached to Secretary Geithner's April 4, 2011 letter to Congress These "extraordinary measures" include using federal employee payroll deductions directed to the G-Fund, which is part of a 401(k)-like program known as the Thrift Savings Program (TSP), and to the Civil Service Retirement and Disability trust fund. These methods have been used in several previous episodes in which federal debt neared its statutory limit.
Section 4 of the Fourteenth Amendment to the United States Constitution, passed in the context of the Civil War Reconstruction, prohibits questioning the validity of all lawfully authorized United States public debt. Bruce Bartlett, a columnist and blogger for The Fiscal Times, argues that Section 4 renders the debt ceiling unconstitutional, and that the President should disregard the debt limit. In July 2011, The Nation editor Katrina vanden Heuvel argued that the President could use the public debt section of the Fourteenth Amendment to force the Treasury to continue paying its debts if an agreement to raise the debt ceiling is not reached.
Keep remembering the important things of life,
Showing posts with label US Debt Limit. Show all posts
Showing posts with label US Debt Limit. Show all posts
Sunday, July 17, 2011
Sunday, June 5, 2011
US Debt Limit
This week the top story was the USA reaching its debt limit of about $14.3 Trillion and the fear of default. While lots of experts have already provided insight on this topic, I want to provide input on the impact for holders of US Treasury Bonds. The first section is from Vanguard. The last section is some trivia for your enjoyment.
Vanguard
While recent reports provided reasons to pause and ponder the condition of the U.S. economy, the gradual recovery doesn't seem to be in danger. Somewhat negative news came from the index of leading economic indicators, existing-home sales, and new residential construction. While economists expected better from all three, there were explanations rather than alarms. The Federal Reserve Board's release of meeting minutes indicated that care must be taken when it eventually weans the economy off its support. For the week ended May 20, the S&P 500 Index fell 0.3% to 1,333 (for a year-to-date total return—including price change plus dividends—of about 6.8%). The yield of the 10-year U.S. Treasury note fell 3 basis points to 3.15% (for a year-to-date decrease of 15 basis points).
US Debt Limit and US Treasury Bonds
If you an investor, this is the main event for the year. The best way to watch this unfold is to watch the US Treasury yield curve that shows the interest rate for all debt issued by the US Treasury. If you are an investor that has purchased these bonds and plan to hold onto these bonds until maturity this has less of an impact than someone who is now purchasing these bonds. The foundation for all investing strategies is that all US Treasury debt has no risk of default so that this is a really, really, really big deal.
Since this is the main event, let's introduce the players like a boxing match. In this corner is the Republican party who say cut spending to reduce future debt obligations. In the other corner is the Democratic party who says that the debt limit should be extended so that it has minimal impact on the economy so that jobs can be created and spending cuts could put our country back into a recession. Who wins? I hope that us citizens eventually win.
Each view has its merits and your view of who is right depends on your perspective. If you are getting a check from the US government you probably are rooting for the Democratic party. If you are the one paying so that another person gets a check you are probably rooting for the Republican party. Everyone wants a balanced budget as long as it does not impact them directly.
Two main points exist in this debate: risk of default and a slowing economy and both impact the interest rates for US Treasury bonds. If a risk of a default exists, then investors will stop buying US Treasury bonds reducing prices and raising interest rates. If the economy slows then investors will start buying US Treasury bonds raising prices and reducing interest rates. You can determine which side is winning by watching the 10 year US Treasury bond interest rate. Since the US Treasury is the largest issuer of bonds this will control the interest rate for the entire economy including mortgages, corporate bonds, car loans, etc.
My perspective is that we will not default on the US debt and we will not slow down the economy. This is high stakes politics and sets fiscal policy for many years and we are the spectators. If we have a risk of default then interest rates go up creating a much larger problem. To illustrate, if interest rates go up by 1% because of this risk on $14.3 Trillion the impact on our budget is $143 Billion annually in higher interest payments. The last thing we need is a $143 Billion rock and the cost of credit for everything we buy will go up. Anyone who is borrowing money wants interest rates to stay low. As far as the impact on the economy, given that the Gross Domestic Product, GDP, for the USA is $20 Trillion if government spending is reduced it will have an impact of a few percent on the economy. I believe that private spending continue to increase regardless of US government spending.
What is the bottom line? The threat of a default risk will take the price for US Treasury bonds higher lowering interest rates. This means that investors should avoid buying US Treasury bonds and any mutual fund that invests in US Treasury bonds right now. Also, if the default risk becomes serious, my recommendation is to get out of all mutual funds that invest in any type of bond and go into cash until this blow over.
This is a fairly complicated topic. Please contact me if you have a question or a concern.
Trivia,
“The taxpayer - That's someone who works for the federal government but doesn't have to take the civil service examination.” Ronald Reagan
"If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.” Milton Friedman
More than half of the coastline of the entire United States is in Alaska.
The Amazon rainforest produces more than 20% of the world's oxygen supply. The Amazon River pushes so much water into the Atlantic Ocean that, more than one hundred miles at sea off the mouth of the river; one can dip fresh water out of the ocean. The volume of water in the Amazon River is greater than the next eight largest rivers in the world combined and three times the flow of all rivers in the United States.
Istanbul, Turkey, is the only city in the world located on two continents.
Vanguard
While recent reports provided reasons to pause and ponder the condition of the U.S. economy, the gradual recovery doesn't seem to be in danger. Somewhat negative news came from the index of leading economic indicators, existing-home sales, and new residential construction. While economists expected better from all three, there were explanations rather than alarms. The Federal Reserve Board's release of meeting minutes indicated that care must be taken when it eventually weans the economy off its support. For the week ended May 20, the S&P 500 Index fell 0.3% to 1,333 (for a year-to-date total return—including price change plus dividends—of about 6.8%). The yield of the 10-year U.S. Treasury note fell 3 basis points to 3.15% (for a year-to-date decrease of 15 basis points).
US Debt Limit and US Treasury Bonds
If you an investor, this is the main event for the year. The best way to watch this unfold is to watch the US Treasury yield curve that shows the interest rate for all debt issued by the US Treasury. If you are an investor that has purchased these bonds and plan to hold onto these bonds until maturity this has less of an impact than someone who is now purchasing these bonds. The foundation for all investing strategies is that all US Treasury debt has no risk of default so that this is a really, really, really big deal.
Since this is the main event, let's introduce the players like a boxing match. In this corner is the Republican party who say cut spending to reduce future debt obligations. In the other corner is the Democratic party who says that the debt limit should be extended so that it has minimal impact on the economy so that jobs can be created and spending cuts could put our country back into a recession. Who wins? I hope that us citizens eventually win.
Each view has its merits and your view of who is right depends on your perspective. If you are getting a check from the US government you probably are rooting for the Democratic party. If you are the one paying so that another person gets a check you are probably rooting for the Republican party. Everyone wants a balanced budget as long as it does not impact them directly.
Two main points exist in this debate: risk of default and a slowing economy and both impact the interest rates for US Treasury bonds. If a risk of a default exists, then investors will stop buying US Treasury bonds reducing prices and raising interest rates. If the economy slows then investors will start buying US Treasury bonds raising prices and reducing interest rates. You can determine which side is winning by watching the 10 year US Treasury bond interest rate. Since the US Treasury is the largest issuer of bonds this will control the interest rate for the entire economy including mortgages, corporate bonds, car loans, etc.
My perspective is that we will not default on the US debt and we will not slow down the economy. This is high stakes politics and sets fiscal policy for many years and we are the spectators. If we have a risk of default then interest rates go up creating a much larger problem. To illustrate, if interest rates go up by 1% because of this risk on $14.3 Trillion the impact on our budget is $143 Billion annually in higher interest payments. The last thing we need is a $143 Billion rock and the cost of credit for everything we buy will go up. Anyone who is borrowing money wants interest rates to stay low. As far as the impact on the economy, given that the Gross Domestic Product, GDP, for the USA is $20 Trillion if government spending is reduced it will have an impact of a few percent on the economy. I believe that private spending continue to increase regardless of US government spending.
What is the bottom line? The threat of a default risk will take the price for US Treasury bonds higher lowering interest rates. This means that investors should avoid buying US Treasury bonds and any mutual fund that invests in US Treasury bonds right now. Also, if the default risk becomes serious, my recommendation is to get out of all mutual funds that invest in any type of bond and go into cash until this blow over.
This is a fairly complicated topic. Please contact me if you have a question or a concern.
Trivia,
“The taxpayer - That's someone who works for the federal government but doesn't have to take the civil service examination.” Ronald Reagan
"If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.” Milton Friedman
More than half of the coastline of the entire United States is in Alaska.
The Amazon rainforest produces more than 20% of the world's oxygen supply. The Amazon River pushes so much water into the Atlantic Ocean that, more than one hundred miles at sea off the mouth of the river; one can dip fresh water out of the ocean. The volume of water in the Amazon River is greater than the next eight largest rivers in the world combined and three times the flow of all rivers in the United States.
Istanbul, Turkey, is the only city in the world located on two continents.
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