Home > Main > Are Investors Paying the U.S. 8% for the privilege of owning U.S. Debt? Zero Hedge and The Daily Capitalist think they are!

Are Investors Paying the U.S. 8% for the privilege of owning U.S. Debt? Zero Hedge and The Daily Capitalist think they are!

February 16, 2011

I like to read both Zero Hedge and The Daily Capitalist.  I find Zerohedge perfectly amusing, but I actually get something out of The Daily Capitalist.

John Williams: The easiest way for the U.S. Government to get out of debt is to issue more debt.

But then, the Daily Capitalist quoted Shadow Stats – saying that inflation might be closer to 8% than 1%.  Fortunately, we have some market indication about what inflation might be.  The equation for Treasury rates is generally given as

Treasury Rates = Inflation Rate + Real Rate of Return

or

Real Rate of Return = Treasury Rate – Inflation Rate

The real rate of return is important, because this is how much money you make after you take inflation into account.  If you make a total return of 3% a year, but the inflation rate is 100% a year, you’re losing your ass in that investment, because you need 100% a year just to retain your purchasing power.

We know the yield for any maturity in the U.S. Treasury Market.  We have numbers from yesterday for the entire yield curve – the market for U.S. Treasuries is one of the most liquid in the world.  Let’s plug in the 6 month Treasury Rate and the Shadow Stats “8% inflation” number into see how much real return investors in U.S. Treasuries are getting.

RR of R = .16% – 8% = -7.84%

-7.84% Real Return.  A negative real return!!  These investors are losing truckloads of money in real terms!  That means that investors are so desperate for Treasuries, they are willing to pay nearly 8% to lend money to the U.S. government for 6 months.  Do you believe investors are paying money to hold U.S. debt?  I do not.

If Shadow Stats is correct, issuing debt is a money making operation for the U.S. government.  If these investors are getting a -7.84% return, that means the U.S. government is making 7.84% on every dollar it lends! That’s a solid return.

Clearly, the best way for the U.S. to get out of debt would be to lend as much money as possible right now – because they are making 8% a year on just lending money!

Of course, this isn’t the case.  The U.S. government is not getting paid to lend money, and it is not making 8% on every Dollar it borrows.

I pointed this out a few days ago, but it bears repeating.  Shadow Stats is very, very, very wrong about inflation.

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  1. Anders
    February 22, 2011 at 2:57 am

    Scott Fullwiler’s 2006 paper on interest rates and sustainability points out that tsys have often yield negative real rates (this is in the context of arguing that rates can practically be kept low – and must be, when govt debt/GDP has become very high).

    However, I agree that the 8% figure is ludicrous.

    • TC
      February 22, 2011 at 7:02 am

      Yes, I was just pointing out that even if the government is mis-measuring inflation, it cannot be by much.

      Is that paper by Scott on his website?

  2. ds
    February 23, 2011 at 3:30 am

    I agree with your point, but as a side note the nominal, real and inflation rates are not additive. The equation is (1 + nominal) = (1 + real) * (1 + inflation)

    • TC
      February 23, 2011 at 8:20 am

      I was waiting for someone to point this out! I do know this very well. But as we all learned in whatever CCC program we were in, for small numbers close to 0%, the addition is a good approximation to the multiplication.

      Let’s see:

      1.0016/1.08 – 1= real = – .07259

      .08 is far enough away to make a real difference I guess.

  3. Peter D
    March 8, 2011 at 11:29 pm

    Scott’s paper which is excellent.

  4. Peter D
    March 8, 2011 at 11:29 pm

    Oops, totally a wrong link!
    This one:
    http://www.cfeps.org/pubs/wp-pdf/WP53-Fullwiler.pdf

  5. Peter D
    March 8, 2011 at 11:45 pm

    But a question. Is the government able to set the rates it pays on its debt by simply deciding on the coupon and taking the hit by selling the bonds at discount if the coupon is lower than the yield sought by the market? Or is it by optimizing the maturities of the offering to the points of most demand to achieve as close a desired yield as possible? Or is it simply, as Scott says somewhere, that the “leash” of the Fed Funds Rate won’t let any other rates escape too much?

    • TC
      March 9, 2011 at 7:39 am

      Is the government able to set the rates it pays on its debt by simply deciding on the coupon and taking the hit by selling the bonds at discount if the coupon is lower than the yield sought by the market?

      I think yes, they are able to set the rates. They did during WWII. Check out this post from a while back on Traders Crucible – Perry Mehrling says the Fed controlled the Yield curve completely. Scott’s point is good – it is a leash…but I think they could take some lessons from the Dog Whisperer. The dog should be following your lead.

      http://wp.me/p1b5Ih-c6

      “Exigencies of war finance soon shifted the focus of the newborn Fed, and the Act was accordingly amended. During both World War I and World War II, the Fed pegged the price of Treasury debt, and expanded its balance sheet as necessary to absorb any excess supply that was not taken up by private buyers.”

      Mr. Mehrling’s blog is excellent all around.

  1. February 16, 2011 at 3:39 pm
  2. April 13, 2011 at 11:56 am
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