Another Reason Why Low Interest Rates and QE are Here to Stay

It’s easy to understand the attraction of things like adjustable-rate mortgages and teaser-rate credit cards. They give you cheap money up front and a few years of breathing room in which to raise your cash flow to cover the eventual higher payments.

Sometimes this works out for the best. But frequently not. If your cash flow doesn’t rise, a big jump in interest expense can ruin your life, as millions of American homeowners discovered when the mortgage bubble burst in 2007.

But the appeal of variable-rate debt endures. Now, amazingly, it’s the US government’s turn:

U.S. Sees Floating-Rate Note by 1Q 2014, Lower Coupon Sizes

The U.S. Treasury Department said it plans to sell a floating-rate security as early as the fourth quarter this year and signaled it may decide to “gradually” reduce the supply of notes and bonds at auction.

In its quarterly refunding statement today, the Treasury said a final rule on the floating-rate note auction is planned for coming months, with a first sale estimated to occur either in the fourth quarter this year or the first quarter of 2014. The department said it will use the weekly high rate of 13-week Treasury bill auctions as the index for the notes.

With a budget deficit of more than $1 trillion last year, the Treasury needs to expand its base of investors. So-called floaters may appeal to those who are seeking to protect themselves from a possible increase in interest rates or faster inflation stemming from the Federal Reserve’s unprecedented monetary stimulus.

“The floaters are being tailored to its audience and also to make it easier to transition into the product,” George Goncalves, head of interest-rate strategy in New York at primary dealer Nomura Holdings Inc., said in a telephone interview.

New Offering

The floating-rate notes would be the first added U.S. government debt security since the Treasury Inflation-Protected Securities, known as TIPS, were introduced in 1997.

“Indexing to the bill rate is likely a function of a preference at the Treasury and because global investors, like central banks, are more familiar buying Treasury bills and are likely more comfortable with this approach to the floaters,” Goncalves said.

The minutes said that James Clark, deputy assistant secretary for federal finance, told the panel that the Treasury was tentatively considering $10 billion to $15 billion in floaters a month and would solicit more market opinions as the first auction approached.

Some thoughts

Just when you think we can’t get any dumber, along comes the next beginner’s mistake, committed by supposedly the smartest people the world’s most powerful government can attract.

As the article notes, variable-rate bonds offer buyers some protection against rising interest rates. But of course the other side of that coin is that it increases the risk from rising interest rates for the rest of us. Already, the federal debt is mostly short-term paper that has to be rolled over every year or two. So rising interest rates would send the Treasury’s debt service costs through the roof as each new rollover is at a higher rate. Issuing longer-term floating-rate bonds would simply streamline the translation of higher rates into higher interest costs. In that sense, the new strategy is like maxing out teaser-rate credit cards to pay off a mortgage; good for cash flow in year one, very bad thereafter.

This is not an issue while the Fed is buying up $85 billion of Treasuries each month and rebating the resulting interest to the Treasury. It’s when the Fed tries to stop that things get dicey. Because a robustly-growing economy – which is the goal of all this borrowing and spending – naturally leads to higher interest rates. During the good old days of 1960 – 1980, the average rate on government borrowing was about 6%, or more than twice as high as today.

But rising rates would send the interest the government owes to non-Fed bondholders through the roof, increasing the deficit and either crowding out productive spending – which would tend to slow economic growth – or creating an even bigger mountain of debt that will require low interest rates to pay off. A 6% average borrowing cost applied to the $20 trillion that Washington will owe in another few years yields an interest expense of $1.2 trillion – every year forever, much of it going to China, Japan, and Saudi Arabia.

To sum up, floating-rate government bonds are just one more reason that interest rates can never be allowed to rise (and QE can never stop), even if it means sacrificing the value of the dollar, yen and euro. Devaluation is the only way out – for everyone.

Source: Dollar Collapse

About the Author

john [at] dollarcollapse [dot] com ()