Joe Shareholder contemplates Treasuries v. Economic Growth

Everyone in the financial world is excited about a possible economic recovery in the third quarter. Signs of stabilization in domestic earnings and economic indicators seem to suggest the end of the recession is near. Economic recovery "Green Shoots" have many investors excited to dive head first back into the markets. Who cares about water depth, right, just dive in? Wrong, the economic recovery water is very shallow, and the concrete underneath the shallow water is the rising US national debt. (Joe Deficit)

As we all know the United States has a budget deficit of over one trillion dollars. So how do we finance expenditures if we're in the hole? We sell debt. The Treasury Department holds weekly auctions to sell US bonds to interested investors at about 3-4% interest. The weekly bond auctions are currently ranging from 30 billion to 200 billion per week. This money is extremely important because it subsidizes tax revenue shortfalls for all government programs, including employee pay and pensions, military expenditures, corporate bailouts (should this even be in the list), etc. So right now we need Treasury auctions because we're broke.

Anyway, suppose the economy starts to improve next quarter, which could happen. If the equity markets (stocks) start to boom, and the market’s expected return is say 10-20%, or even 50% over the next couple years, why would anyone invest in our US bonds at 3% yearly return? They wouldn’t, and either a vital source of revenue would dry up - or the more likely scenario - rates would be pushed higher during treasury auctions, to say 10% on the 10 year treasury bond to lure in buyers. There are several problems with that:

1. Every dollar the US gov borrows would be very expensive at 10% interest. US Treasury would have to lower the amount of US bonds at auctions, which would dry up funds. Who would bailout the banks next time? Who would pay entitlements? Nationalized Health Care? How would the military be financed? Cap and Trade? (Joe-bal warming)

2. The US housing market needs low interest rates. Housing mortgage rates follow the 10 year treasury bond very closely. If the yield on treasuries is driven up to 10% because of a lack of demand at auctions, then the rates on mortgages would be pushed up to about 12%, which would cripple a fragile housing market. You think you're upside down in your mortgage now? (Joe Housing .....spelled upside down)

3. Right now the Federal Funds rate (interest rate at which banks borrow from the Federal Reserve) has been cut to zero by the US Federal Reserve. When you buy a house, your bank/lender can borrow the money at zero interest and lend it to you at 5% interest. If the treasury yields skyrocket, however, the Fed won’t be able to hold these rates at zero long, because they’ll be paying 10% and loaning it out at 0%. Not sustainable for long. This rate increase will negatively impact business loans as well, and credit markets could easily seize up once again, separating borrowers and lender. (Joe minus Kate and the eight)

Enter the US debt into the picture. If we didn't have such a huge national debt, we wouldn’t depend on treasury auctions to pay soaring interest on existing debt, and the auctions would be scaled back significantly from 200 billion per week to almost zero. Under this scenario, depressed supply would meet low demand at low interest. However, since our government desperately needs revenue we will need large treasury auctions and the rates will likely be driven upward (low demand, high supply). The only way out of this debt trap is a booming economy, where tax revenues would offset the need for treasury auction revenue. Most economists suggest this is unlikely, especially with dangerously high levels of unemployment. (Joe Monster.com)

Why don't we just print money? Because just printing money not collateralized by interest would lead to hyperinflation and the US dollar - which is supporting a huge deficit - would simply go down the drain. (Joto Rooter)

In summary, our national debt has economic growth hamstrung right now because rising equity markets will spur interest rate hikes. The only sensible exit strategy is to ween the government off the important revenue stream of treasury auctions and cut the deficit. Because of the inverse relationship between debt and recovery, every dollar that we spend will actually hurt chances of recovery, not help.

So what does this mean for Joe Shareholder??? Joe Shareholder and his friends Joe Investor and JoAnn Trader desperately want to jump back into the market to make money to buy a boat, dirt bike, and maybe even a trailer to haul it. Maybe even a truck to pull it. F-350 Turbo Diesel maybe, with knobby tires. However, beware of this stock market rally. You might go broke. (Joe Soup Kitchen) The threat of rising interest rates due to our National Debt could cause more market shrinkage than a cold swimming pool nestled in the middle of the shrinking polar ice caps. (Joe Gore)