Mr. Quarter on Riding the Rim of the Bowl

A curious and little noticed thing happened the other day during the Obamacare fiasco. Berkshire Hathaway sold corporate bonds with a lower interest rate than US Treasury bonds commanded at auction in the same period. What, you may ask, has that to do with anything that concerns me? Simple. The market has determined that Berkshire Hathaway is a better credit risk than the United States.

During the Obamacare debate, the Democrats touted the Congressional Budget Office scoring of their bill as “bending the cost curve down” with an ultimate savings of $138 billion over 10 years. Unfortunately, the CBO is required by law to score legislation using assumptions, no matter how ridiculous or unrealistic, dictated for that bill by the Congress (led and dominated by Democrats). The method used in scoring the Obamacare bill double counts Social Security payroll taxes, long-term care premiums, and Medicare savings. Consequently, independent auditors, including a former director of the CBO, have estimated that the real 10-year cost of Obamacare is deficit spending to the tune of $580 billion to $618 billion – depending on whose estimate you accept. Apparently the bond markets have taken notice of this discrepancy and are pricing US Treasury debt accordingly.

The 2010 budget includes a deficit of $1.6 trillion which must be financed by selling US Treasury bonds. In addition to that, approximately $2 trillion of US Treasury bonds will mature this year and must be refinanced or paid. Assuming that it is refinanced with the sale of more US Treasury bonds, a total of $3.6 trillion in US deficit must be financed in 2010. Our largest foreign creditors China, Japan Britain, the Gulf States are likely becoming more and more reluctant to increase their Treasury holdings given our almost insatiable need to finance the business of the US government with debt.

Economists often speak of national debt at 90% of GDP as a “tipping point” signaling that a country is approaching default and will shortly be unable to repay all that is owed. Prior to the TARP bailout, total debt owed by the US government was approximately 70% of GDP. After TARP it is close to 90%. US debt is projected at $19 trillion by 2015 (that is in 5 years folks). Rounding generously upward, the GDP for the US in 2009 is estimated at $14.5 trillion. Allowing for 3% annual economic growth for the next 5 years, GDP in 2015 can be projected at $17.3 trillion. That means that projected US debt in 2015 will be on the order of 110% of GDP. Try getting bidders for US Treasury bonds at desirable rates with that condition in place.

What happens if no one will bid at the desired rates? The Federal Reserve can monetize the debt, as it has been doing for the past year, and step in as the "lender of last resort” buying US Treasury bonds. That’s right, the Fed makes an accounting entry paying out (i.e., creating) billions or trillions of dollars and takes an equivalent value in US Treasury bonds onto its balance sheet. That is, the Fed will be printing money to pay our bills. Creating money out of the thin air inflates the value of goods and services relative to the value of the money paid for them. Concurrently, the US Treasury will have to offer higher and higher interest rates to attract investors to purchase its debt. A vicious spiral downward into oblivion.