inflation Archives - Page 2 of 2

The United States does not currently issue bonds with maturities longer than 30 years, but the idea of super long-dated national debt is back in the air. Long-dated, as in bonds due in 100 years. One reason 100-year bonds are kind of neat is that nobody alive right now ever needs to worry about paying the principal back!

Setting snark to the side (for just a moment), Treasury Secretary Steve Mnuchin, in an interview in December, appeared open to the idea of 50-year or 100-year bonds, floated by financial newspaper Barron’s back in November 2016.

Barron’s followed up in February with the report that Mnuchin asked his staff at the Treasury department to look into the pros and cons of 100-year debt.

Some of the best reasons for the United States to issue 100-year bonds fit reasonable, prudential, debt-management principles. Other reasons facilitate wackier scenarios. I’ll describe both.

But first, who would buy 100-year bonds from the United States? Buyers are not typically individuals like you and me, but rather institutions that have to make payouts far in the future.

Barbara Mckenna, Managing Principal of Longfellow Investment Management Co, a Boston-based firm managing over $9 billion in assets, noted to me last week that buyers of ultra long-dated bonds tend to be pension funds and life insurance companies, institutions which need assets to match their liabilities, stretching into the future for many decades.

These were the buyers for Austria’s 70-year debt issued in late 2016 at a rate of 1.53 percent. Ireland and Belgium both issued 100-year bonds earlier in 2016 presumably to that type of buyer as well, both reportedly with a 2.3 percent coupon.

“Feed the ducks while they’re quacking,” we’d often say in my old bond salesman days, when we issued new debt. There’s an element of that to justify the US issuing 100-year bonds. Right now, the pension funds and insurance company ducks would happily quack for extremely long-dated US Treasuries, so we might as well satisfy their hunger.

The three most legitimate reasons for the US to issue ultra long-term debt are:

To ease “rollover” risk,
To fund ourselves at historically low rates, saving money, and
To facilitate long-dated corporate bond issuance

First, if your country issues mostly short-term debt, as ours does, the “rollover” problem happens constantly. If you have, on average, more long-term debt including for example 100-year bonds, you’ve gone some way toward relieving your rollover problem.

Next, the cost-savings from long-term low rates could be significant. A few numbers can help put this into context.

The federal government currently owes approximately $19 trillion to all creditors, and paid $433 billion in interest on its debt last year.

The federal government pays 2.26 percent on all of its debts, as of March 31, 2017, an extraordinary low rate.

15 year ago, the average interest rate on long-dated bonds was 8.27 percent.

10 years ago, the average interest rate on long-dated bonds was 7.55 percent.

Right now a 100-year bond – depending on a variety of factors such as the size of issuance and the demand from investors – could cost something like the current rate on 30-year bonds, or approximately 3 percent per year. McKenna agreed with me that a 100-year bond “probably would not be dramatically different from a 30year bond in terms of yield.” It might cost the US government a bit more, although it also might cost less.

While a 3 percent 100-year bond would represent a higher rate than the US currently pays on average over all, locking in that rate for a long-time probably offers big interest cost savings over the long run.

We’ve got close to $2 trillion in long-dated bonds outstanding currently, due between 10 and 30 years from now. To point out some simple math (albeit simple math with a lot of zeros involved) a 1 percent drop in the average interest rate on a trillion dollars in long-dated bonds saves $10 billion per year in interest payments.

The third reason for 100 year bonds – and this reason appeals more to bond nerds like me, concerned with smooth-functioning capital markets – is that private corporations can issue more long-dated debt if there are long-dated US Treasury bonds to compare them to. Bond traders really like corporate bonds to match the length of government bonds, as it makes hedging and trading those corporate bonds much easier.

So 100-year US Treasury bonds aren’t crazy, could be issued affordably, and offer some capital market advantages.

Now, you’ve been patient with me and my bond math, so let’s get a little crazy. For readers interested in historical bond trivia – and yes, I’m talking to both of you – ultra long-dated bonds have interesting ties to global catastrophes.

England issued perpetual bonds to finance itself during the Napoleonic Wars, and 100-year debt to finance itself during World War One.

I think of this global catastrophe and 100-year bonds because a time may indeed come in the medium-term future when we have trouble rolling over our debts.

If we were in a shooting war with China – or even just a nasty trade war – for example, we might have trouble with the fact that Chinese institutions own approximately $1 trillion of US sovereign debt. Heck, if we get into a shooting war with North Korea this week or next week we might face rollover trouble, as a signal from Chinese institutions displeased with our unilateral military actions.

Fortunately, our current President has deep experience with the inability to roll over debts. He ran his casinos into the ground this way. Given his experience, he stated his plans for federal debt issuance while still a candidate, just last summer.

“I’ve borrowed knowing that you can pay back with discounts. I would borrow knowing that if the economy crashed, you could make a deal.”

Oh, sweet mercy, please, no. But then a few days later candidate Trump clarified, default isn’t really necessary. “People said I want to go and buy debt and default on debt. I mean, these people are crazy. This is the United States government.”

I was starting to feel better.

But then he continued,

“First of all, you never have to default because you print the money, I hate to tell you, okay, so there’s never a default.”

Ah, yes. Thank you Mr. President for clarifying your views on sovereign debt.

Dear Treasury Secretary Mnuchin: Can we please issue massive amounts of 100-year bonds quickly before anyone re-reads these quotes and thinks about them too closely?

A version of this post ran in the San Antonio Express News and the Houston Chronicle.

Please see related posts:

Trump and the coming Financial Crisis

Trump: Sovereign Debt Genius

Book Review: The Making of Donald Trump by David Cay Johnston

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The “Rent v. Buy” discussion offers endless opportunities for debate.

We can talk about the opportunity to buy a piece of the mythical ‘American Dream’ – on the path to acquiring key accessories like a white picket fence, 2.3 children, and a Viking stove.

We can talk about the extraordinary risks taken by mortgage borrowers borrowing to the maximum before 2008 and the devastating financial losses many suffered in the aftermath of that financial crisis.

We can talk about the pride of fixing up one’s own dwelling as an owner. Or just as easily, we can note the smug satisfaction of calling Bob the superintendent and ordering it done. Make it quick, Bob!

Some of these preferences derive from personal leisure time preferences, risk tolerance, or lingering Leave It To Beaver fantasies. I don’t have any comment on those factors.

I do have comments, however, on the financial implications of the Rent v. Buy debate.

Online calculators

You can find delightful Rent v Buy calculators online.

I prefer The New York Times’ calculator myself, but there are other great ones on various realtor’s sites as well as brokerage sites. Another site, BankRate.com walks you through a series of qualitative questions to determine suitability for home ownership versus renting. These are all fine and cool.

I do not recommend spending too much time with any of these online models, however, because ultimately the financial models depend on inputting assumptions about a bunch of unknowable future financial factors. Do you know what your income taxes and real estate taxes will look like five years into the future? Do you know the future rate of inflation, the rate of increase in rent, the insurance and repair costs of a home? I mean, if you had certainty and accurate insight into these things you’d be running a high frequency trading fund by now, not fiddling around with online rent v. buy calculators.

I’m in the ‘making things simple’ business, and I believe you only need to satisfy two conditions to make the move from rent to buy.

First thing: Do you have a steady, predictable income? If you do not, then home ownership is a terrible idea. It’s just too risky.

Second thing: Do you plan to stay in the same place for the next five years? If not, real estate values are too volatile to mess with, and the frictional costs of getting in and out of real estate ownership are too high – after factoring in brokerage, title, loan, and attorneys fees.

So that’s it: If you’ve got a steady income and plan to stay five years in the same place, then go for it.

Wait, I haven’t said this strongly enough.

Commodities Trader says Buy — Commodities Guy says: BUY! BUY! BUY!

Picture me for a moment like those commodity trading pits guys (who don’t really exist anymore) a phone in each ear and tie askew, hands gesticulating wildly and shouting “Buy! Buy! Buy!” into both phones simultaneously. That’s how strongly I feel about the financial advantages of home ownership, if you can satisfy my two conditions above.

In order of importance, here’s why home ownership offers powerful financial advantages.

Automatic Savings

I can’t prove this, but I’m convinced this is the most important financial reason to buy a home. Most of us have no extra money month-to-month, so the idea of putting money away for long–term investments is, let’s say, elusive. But when we own our home with a mortgage, we end up paying small chunks of principal in the ordinary course of paying for our shelter. Over 30 years many middle-class homeowners manage to sock away hundreds of thousands of dollars of wealth without much pain because it happens monthly, automatically, even sneakily.

Tax Advantages

Everybody talks about the mortgage interest tax deduction, which is fine, but not the most important tax advantage of home ownership. The most important tax advantage – by far – is that in most scenarios when you eventually sell your home, $250,000 of capital gains are tax free, or $500,000 for a married couple. No other financial asset offers that kind of tax-free growth in value. Not only that, but real estate taxes are deductible from federal income taxes, as are other mortgage expenses like ‘points.’ Home ownership is just a great big bundle of tax advantages, courtesy of your middle-class homeownership-pandering Congress. Thank you US Congress! We love you! Muah!

Inflation hedge

Hey gold bugs, you’ve got the wrong idea. Home ownership is an awesome inflation hedge, because you can reasonably expect the price of your home to go up in line with inflation. When you rent, inflation hurts. When you own, inflation helps. If you own a home, especially with a mortgage, you can be all, like, ”Inflation? Bring it on! I am hedged!”

Leverage

That’s finance-speak for buying more than you can actually afford, through borrowing. Of course being debt-free is a great idea that everyone should aspire to, but the leverage part of home ownership has long been a key part of middle-class wealth-building.

Outside of mortgages, lenders will never offer you 4-to-1 leverage, meaning the chance to buy a financial asset by only putting 20% upfront and paying off debt over time.

How does leverage work?

If you put down just 20% of the value of a thing, and then the thing goes up in value by 10%, with 4-to-1 leverage the value of your ownership in that thing increases by 50%. This is amazing! Obviously leverage (aka debt) is a double-edged sword and can lead to catastrophic losses if your thing goes down in value by 10% (or more!) But still. Leverage!

Small print disclaimer before my summary conclusion: I have not mentioned the issue of down payment (you need it!) and decent credit (you need it!) when deciding on Rent v. Buy. So there’s that to consider as well. But for now let’s focus on the simple message below.