By Sean Kelly

Today we want to take a different look at our country’s financial picture.  You might call this the view from 35,000 feet.  From this altitude it is hard to miss two things that do not go together.

  1. We have the lowest interest rates in history.
  2. At the same time, the US is the biggest debtor in history.

Although the long-term average 10-year US Treasury rate is close to 4.5 percent, two week ago, the ten-year US Treasury note dropped to a yield of just over ½ percent annually (0.52%; blue line).  We will skip for now the question of who in their right mind would be willing to loan money to the US government for 10 years for such a pitiful return. Nevertheless, we are in the lowest interest rate environment in civilization’s 5,000 year history.

And yet, at the same time, the US government is the biggest debtor in history.  At $26.5 trillion, the gross federal debt (red line) is now even higher than reflected in the following Federal Reserve chart.

Rising Federal Debt

Record high debt and record lower interest rates are an anomaly; they cannot peacefully co-exist.  Today’s rates are so low Congress acts like it can borrow for free, so it adds to the debt at a furious rate.  To help, their enablers at the Fed blow up the bond market bubble bigger and bigger to keep driving rates down.  But the combination of the two is unsustainable.

Bubbles always pop.  Right now, some creditors are whistling past the soon-to-be graveyard of the bond market bubble; others are beginning to reduce their exposure to the coming collapse.  All of them will eventually demand higher interest rates from risky and over-extended borrowers, and that includes their Uncle Sam.  We understand higher interest rates for the over-indebted.  It is something we all know from daily life.  Those burdened by too much debt pay higher rates for car loans, credit lines, and mortgages.

The inescapable conclusion is that either federal debt will have to come down or that interest rates must rise.  After World War II, war spending was slashed, and more than 10 million members of the military were demobilized to return to economically productive activities.  As a result, over the next several decades the debt to GDP ratio fell by 70 percent.  Because there are no comparable possibilities before us today, no army to demobilize, no politically palatable spending cuts or massive tax increases likely in this depressed environment, interest rates will have to rise.

Rising interest rates will be a calamity for the stock market and especially for those companies that borrowed heavily to buy their own shares.  A bond market crash in this environment will drive those fleeing the bond market not into stocks, but into precious metals.

We are already seeing a lower US dollar; the Swiss franc and the euro are both higher over the last couple of months.  We have discussed the global de-dollarization movement as key evidence that interest rates will have to rise.  As we wrote here at The Gold Watch three months ago, the repositioning of global central bank reserves “out of dollars and into gold may prove to be the most significant megatrend of this decade.  It is a shift in global monetary management that can damage the dollar badly and propel gold much higher.”  (See They’re Ganging Up Against the Dollar.)

Speaking of de-dollarization, investors should note the setback the US received in the UN Security Council vote last week on an extension of the UN arms embargo on Iran.  It was a major defeat for the US, one so lop-sided that it is being described as “humiliating.”  We mention this not as a comment on, or critique of US diplomacy, but to point out that cracks US geopolitical hegemony go hand in hand with waning dollar hegemony.

The world is changing.  In the end financial reality asserts itself.

Lowest rates.  Biggest debtor.  That can’t last.

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