The real long-term truths about Uncle Scam’s current situation:
By Daniel at 13 July, 2009, 4:33 pm
1.) Actual revenue (i.e., tax receipts) will continue to fall well below expected/rpojected revenue for the foreseeable future. Whatever the source of revenue (i.e., taxes), from individual income taxes to corporate income taxes, the revenue base has been significantly damaged. Translation, Washington’s deficits will be bigger and bigger driving the debt offerings higher and higher. The continued shortfalls in tax receipts should not be a surprise to anyone.
2.) Who in their right mind can justify underwriting US debt currently. Just applying the simplest underwriting concepts such as the ability to generate positive EBITDA, have positive debt service coverage ratios, etc. all indicate that US debt, at best, should be classified as junk (if the rating agencies really had any backbone). Based on a SWAG (i.e., scientific wild a** guess), the US is currently spending 20 to 25% of its total revenue on just interest expense. Ask any finance source to underwrite a deal where the customer has negative EBITDA and consumes 25% of its revenue for interest and you would get laughed right out of the building as fast as possible.
3.) Numerous questions have been presented recently about who is actually buying all of this federal government debt. The logical conclusions are foreign central banks, the Fed, etc. (which are to a certain degree correct). However, everyone should also remember a key financing concept that is currently assisting the US debt offerings. That is, at the low point of any economic cycle, when everyone’s balance sheets have contracted (i.e., receivables reduced from lower sales, inventory the same, reduced equipment purchases, etc.) , excess cash is generated (unless you’re covering losses) which can be set aside to build liquidity, distributed to shareholders (not likely in this environment), or to reduce debt. If no debt is present, what is a company to do with the cash - set it aside and invest in low risk money markets which tend to invest in only the highest graded and most liquid instraments including T-Bills, commercial paper, etc.
My point is that at the peak economic contraction point, excess cash is generated which is providing additional sources of capital to finance the debt offerings. With not much else to choose from, the cash is dumped into the lowest risk investments which is helping the government with their shorter term debt offerings. Also consider the fact that banks have significantly reduced lending levels (actual and committed) to weaker busineses while stronger businesses don’t need to borrow as much. Again, the contraction drives cash in the banks which in turn basically invest it, in one form or another, US debt.
So here we have a great Catch 22. One one front, the government needs to the economy to expand, generate jobs, higher income, to drive higher tax receipts (not to mention protecting the current adminstrations 2nd term hopes).. On the other front the government can’t affort a recovery as when the economy expands, businesses need credit/financing so the source of capital sorely needed by Washington is now in demand by the private sector (and Washington will have to compete for that capital, thus driving interest rates higher and potentially choking off a recovery). Remember a critical financing lesson - For well run businesses (i.e., not GM types), you don’t need financing entering into a recession/correction but you sure as hell need it when you begin to expand again.
So the question has to be asked - Can the government afford real economic growth? My guess is that the government is going to attempt to take on as much debt in the next five years as possible (while the USD has some value left in the world before it is displaced) and then let inflation consume the economy. Eventually, all of the old debt will be paid back with USD’s that are worth much, less similar to how a mortgage originated 15 years ago is paid with current earnings. Of course the other option is to use it’s SPE’s (i.e., special purpose entities) such as the Fed to monetize the debt at a much quicker rate and just get to the inflation scenario quicker. Either way, two truths will eventually come about - high inflation and a much lower USD value in the global market.
BTW, wasn’t it the SPE’s that eventually brought down Enron earlier this decade which created such a stir in the accounting world (including launching SOX’s)? Funny how the government can demand that basically all large businesses operating in this country abide by some of the strictness reporting standards in the world yet doesn’t require itself or the Fed to play by the same set of rules. Just like the study of geology as noted by Tim Robbins who played Andy Dufrane in the Shawshank Redemption, Washington’s situation is “just a matter of time and pressure”.
WASHINGTON (AP) — Nine months into the fiscal year, the federal deficit has topped $1 trillion for the first time.
The imbalance is intensifying fears about higher interest rates and inflation, and already pressuring the value of the dollar. There’s also concern about trying to reverse the deficit — by reducing government spending or raising taxes — in the midst of a harsh recession.
The Treasury Department said Monday that the deficit in June totaled $94.3 billion, pushing the total since the budget year started in October to nearly $1.1 trillion.
The deficit has been propelled by the huge sum the government has spent to combat the recession and financial crisis, combined with a sharp decline in tax revenues. Paying for wars in Iraq and Afghanistan also is a major factor.
The country’s soaring deficits are making Chinese and other foreign buyers of U.S. debt nervous, which could make them reluctant lenders down the road. It could force the Treasury Department to pay higher interest rates to make U.S. debt attractive longer-term.
Rodan
No comments yet.