INDEPENDENT INSIGHTS Market insights from an independent perspective


February 19, 2019

Kevin Karpuk CFA

“’Tis against some men’s principle to pay interest and seems against others’ interest to pay the principle.” - Benjamin Franklin
Debt can be beneficial if properly structured. Interest rates fixed at low levels for long periods of time can yield profits, but woe is the borrower seduced by low rates that reset often. History is riddled with examples of people, companies, and countries whose borrowing terms did not match their ability to repay their loans. Recent examples include homeowners in 2008 with adjustable rate mortgages, Lehman Brothers, Bear Stearns, Argentina, and others. There are no atheists in foxholes and no friends in banking during a credit crunch.

As of February 14, 2019, the United States’ federal debt was over $22 trillion and expected to grow by $1 trillion per year through 2022.[1] It appears everyone understands that the United States has a borrowing problem, but there is a divergence of opinions on what exactly that problem is. Some think we have borrowed too much, while recently some have argued that we are not indebted enough. The latter group consists of believers in Modern Monetary Theory (“MMT”.)

For most of its history, MMT has been a dispassionate accounting theory – private flows and public cashflows must sum to $0 absent inflation. However, for our purposes, we are using the recent political description: increasing public debt to fund social projects. According to MMT, government that can print its own money cannot go bankrupt. But what if there is not a limitless appetite for U.S. Treasury-backed debt?

The chart above shows that the Treasury Department has extended the average maturity of its debt since the Great Recession. Unlike the previous examples of enterprises that failed because of a liquidity crunch, this maturity lengthening should provide a buffer for the government because it must refinance its debt less frequently. However, these numbers are skewed.

Since the advent of quantitative easing, a new funding source for our fiscal deficit has appeared: the Federal Reserve Board of Governors. The Fed currently owns 15% of our government’s total marketable debt and almost 30% of bonds due in ten or more years,[2] but it has also committed to eventually unwinding these positions. Given the coming surge in debt issuance, which will only be exacerbated if MMT becomes mainstream economics, will the government find willing buyers at reasonable terms, or will interest rates increase and cause an unsustainable debt cycle?

We often focus these pieces on short- to medium- term actionable items. This is not one of those times. We do not foresee demand drying up in the near term, but if, as a nation, we cannot pay down the principal outstanding, perhaps it is in our interest to control its growth. As always, thank you for reading along with us and please feel free to reach out with comments or suggestions.

[1] Source: United States Department of the Treasury and Office of Management and Budget estimates.
[2] Source: Board of Governors of the Federal Reserve System, “The Federal Reserve’s Balance Sheet” September 30, 2018.

Kevin Karpuk, CFA Chief Investment Officer

Kevin is Cornerstone’s Chief Investment Officer and is involved with the firm’s Investment Policy and Strategic Planning committees. Kevin joined the company in 2000 after graduating from Lehigh University with a B.S. and M.S. in Economics and earned his CFA charter in 2005. Kevin and his wife Kat support many charitable causes and have established a donor advised fund to propagate their philanthropic interests. They live in Bethlehem with their two cats: Zola and Charlyne, enjoy woodworking, gardening, reading and travel. Kevin is the proud uncle to many nieces and nephews and loves spending time with and spoiling them.

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