I was watching Mary Poppins with my 4-year-old on Saturday night - Mom life at its finest, to be sure!
My little guy didn’t understand the scene where Michael and Jane go to work with their father at the bank for the day, and Michael is upset because his father makes him invest his tuppence, instead of letting him spend it to feed the birds.
“Give me back my money!” Michael yells at the bankers. “It’s mine to do what I want with!”
The crowd in the lobby hears this, and unrest sparks immediately.
”Someone is having a hard time getting their money back? Well, I’ll surely have every penny of mine!” exclaims one woman, triggering an eventual bank run as everyone panics and lines up to withdraw their deposits. [I was not sure how to explain this to my son, so I told him we’d go to a bank later as a field trip and talk about it then!]
Why am I talking about Mary Poppins in a financial newsletter?
Because its a perfect illustration of the single most powerful lynchpin required for our domestic and international financial system to run: trust.
Trust that a bank will invest your deposits wisely (whether in the form of loans or otherwise), and you’re happy to leave it there and earn a return. The bank makes money, you make money, everyone walks away happy.
Trust that the US government will make its interest payments to you when you loan it money (this is what happens when any person or entity purchases Treasury Bills - its just a loan to the Federal Government that’s repaid over time with interest, also known as a “coupon”) and you’re happy to sit back and collect your payments. The government can finance its spending, you earn a return, and everyone walks away happy.
On the flip side?
Lost faith in a bank’s solvency leads to panic and every depositor rushing to pull their funds out at the same time, which will inevitably lead to that institutions collapse (eg, Silicon Valley Bank in 2023) unless the US Government steps in (eg, TARP circa 2008).
Lost faith in a government leads to uncertainty and that government having to pay higher and higher amounts of interest in order to attract lenders (e.g., purchasers of that country’s debt). This is known as “yield,” or the return an investor requires in order to take a specific amount of risk.
The higher the perceived risk, the higher the yield (see: Greece circa 2010 where bond yields exceeded a record-breaking 11%).
11%?! We’re talking hard money loan territory here. This is a place that no country wants to go.
Think about any loan you might currently have - a car loan, a mortgage, student loans perhaps… can you imagine paying 11% for any of those things?
Say you obtained a 30-year, fixed rate mortgage for $450,000. If you had a ~7% rate like most folks with a decent credit score and income history are able to lock in right now, your first monthly payment would $2,994 (principal and interest only), comprised of just $369 to principal and $2,625 to interest.
You would pay $627,790 in interest over 30 years.
If you had an 11% interest rate because you were perceived to be a much riskier borrower for any variety of reasons, your first monthly payment for the same loan and term ($450,000 over 30 years) would be $4,285 with just $160 towards principal and $4,125 toward interest.
You would pay a whopping $1,092,764 of interest over 30 years. For the exact same thing. That means that you would necessarily have $464,974 less dollars to spend on other stuff during the same time period. Ouch.
Right now, the United States government has a fiscal deficit of over $1.3 trillion dollars. In other words, the government has spent (past tense, as in, money already out the door) $1.3 trillion more than it’s brought in.
How is that possible?
Its possible because the government borrowed the money, just like you or I might borrow $450,000 to buy a house!
How did the government borrow the money? Via the issuance of Treasury Bills, which have been historically purchased and held by local and international investors alike because they were perceived to be the safest type of financial investment out there.
There’s a reason the T-bill rate is (…was) referred to as “the risk free rate of return” in any corporate finance class when you’re first learning about the weighted average cost of capital, discount rates, and all of those fun finance terms that make for great gifs but not so great cocktail party conversation starters.
It was literally considered to be risk free, because the US Government was assumed to never act in a way that would jeopardize the repayment of these loans.
Treasury bill auctions happen on a regular basis, and there is not set ‘cost’ to purchase one of these securities - meaning, as the government needs to borrow money, it will issue more Treasury Bills (“T-Bills, for short).
The price the government has to pay in the form of guaranteed interest to entice buyers to invest in T-Bills goes up and up and up as they are perceived to be riskier and riskier.
Remember our example of a $450,000 loan at 7% vs. 11%?
Now imagine a $1.3 trillion dollar loan that costs 4.5% instead of 0.5%. There are so many zeroes in that math that I’m not going to bother with it, but you see the point here.
A massive increase in interest expense for the Federal Government means that there is less money available in the budget to pay for everything else - this includes Social Security, Medicare, defense spending, pensions, public works/schools/roads/parks, and so on.
In fact, as of about this time last year, the US Government spent (and continues to spend) more on interest payments than on defense spending.
This would be problematic in and of itself, but here’s the bigger picture.
Remember those T-Bills that the government issues to finance its operations - however far in the red we’re apparently going to head, especially if the 2017 Tax Cuts and Job Act is permanently extended for an estimated ~$5 trillion increase to the federal deficit?
Who do you think buys those? I don’t have a trillion dollars. Do you?
Want to take a guess at the value of US Treasury Bills owned by non-US investors, eg, creditors?
$32 trillion!
Our government currently owes the rest of the world $32 trillion dollars (plus interest! which continues to increase!) yet continues to operate as if we have an endless supply of monopoly money (hint: we don’t!)
We also continue to operate as if we have earned the trust and right to do business with whomever we want, whenever we want, however we want (hint: we haven’t).
Trust is mutual, must be earned, and requires consistent proof and action to maintain.
You can’t just say that everyone loves you because you’d like it to be true. You actually have to DO things to make others love you, such as treating others with respect and keeping your word.
Poking all of our trading partners in the eye and hitting them with capricious and nonsensical tariffs erodes trust in the Federal Government, as does pointless social media tirades attacking the Chair of the Federal Reserve
These sorts of things that do nothing but drive up the cost of goods for individual consumers (if you don’t believe me, just take a look at your grocery bill over the next 90 days).
Bigger picture: if the independence of the Federal Reserve is called into question, the debt-financed free American lunch is going to be gone forever.
Party’s over, Wayne!
Why? Because no one will trust the United States financial system anymore. Its already happening. Take a look at the value of the USD. It ain’t pretty.
Ever traveled through rural South or Central America where a sandwich costs the equivalent of $10,000 in local currency? Let that sit for a minute.
We are already so overleveraged as a country that if the United States were a company, its debt would be well on its way to series of downgrades that would make it more and and more expensive to borrow and finance operations.
The increased cost of debt would potentially result in the company ceasing to exist via liquidation or foreclosure by the company’s creditors. The conversation would go something like this:
[creditors] “You know what? I don’t actually think you have a good turnaround plan, or the right people in place to make this thing solvent again. You’ve had years of extensions to figure it out. You also keep insulting us on social media, which seems like a pretty poor use of time given how far in the hole you are.
We want our money back, because we don’t trust you. We’re better off cutting our losses and selling. You have 60 days to get your books in order and we’re going to liquidate this thing. Good luck to you.”
[company] “well, crap.''
Let’s consider whether or not the reality TV star who’s bankrupted 6 companies (I worked on the purchase of one of them by one of my borrowers at Wells, so got to enjoy reading the legal review detailing everyone from contractors to creditors not getting paid for their work and losing their entire investment), who got a $400 million+ head start in life and therefore never had to try or learn things (like, you know, economics or epidemiology) actually knows what he’s doing.
He doesn’t. He’ll be fine.
We won’t.
What might happen, if things continue on in this direction?
That $32 trillion dollars of debt is going to hit the secondary market at a steeper and steeper discount, which will drive up the interest payments the US Government is required to make to entice anyone to loan us money, which will lead directly to financial ruin (see earlier comment on Greece in 2010).
Btw: China and Japan are already net sellers of US T-Bills. If that doesn’t make your hair stand on end, I’m not sure what will.
Do you like receiving social security payments, or having federally subsidized Medicare, or a government pension? Do you like having a functioning military? Do you like roads and schools and libraries and national parks?
If we can’t afford to make interest payments on our debt, all of these things are going to go the way of the Dodo bird. This doesn’t even consider a war or national catastrophe that might require raising a significant amount of capital quickly. If we already can’t pay our bills, we aren’t going to be able to respond meaningfully to a crisis. This is as terrifying as it is tragic for a country like the United States that had earned a reputation as being trustworthy.
As a country, we’ve basically been allowed to operate with a monopoly money mentality when it comes to deficit spending for the last couple of decades because the global marketplace trusts the US Government to make good on its commitments, and trusts the Federal Reserve to remain an independent institution.
That trust is waning by the minute.
If you have the ability to obtain a non-US passport, might not be a bad thing to consider. If you don’t have an emergency fund with at least 6 months of living expenses set aside, start TODAY. And if you have some time, consider writing to your Congressperson and asking the government to prioritize doing its basic job, which is maintaining a balanced budget and services and stability for its citizens.
I am sure that as a country we’ll make it through, but I’m equally sure that it’s going to get a whole lot worse before it gets better.
Hope I’m wrong.