Financial writer Tim Denning recently did an article on the national debt and other assorted matters of interest to investors. He shows us how low the bar really is.
We originally were attracted to a recent article by Tim Denning, a freelancer who writes for several popular financial media sites, with a title that would grab just about everyone’s attention who is even the least bit interested in the world of finance, called “Warren Buffett’s Recent Explanation of How Money Now Works is the Most Important in History.”
That’s a pretty impressive and interesting title if there ever was one. We’re a fan of great titles, and this one is a 10 out of 10 if you want to get people to read your article. It even grabbed our attention even though if we wanted to know how money worked, we wouldn’t be asking Warren Buffett as he is no expert on the matter and we did not expect him to know very much about these things.
It turns out that that Warren’s ground breaking explanation, the one that impressed Denning so much that he is calling it the most important explanation in history, is his telling us that the U.S. government will not be paying back the money it borrows but instead will be refinancing it.
You can literally find much better explanations of this on sites designed for kids, describing how the U.S. Treasury works and such, although neither Buffett or Denning have availed themselves of even an understanding on this primitive of a level, at least up until Buffett’s eureka moment. Buffett is right, they won’t be paying it back, but that’s no revelation at all, and the U.S. government has done it this way all along as do all other governments.
We’re not even sure what is noteworthy about this alleged profound explanation of how the U.S. Treasury works, but Denning believes that this alleged new revelation from Buffett is being followed up by his “betting against the United States” by placing a big investment in gold lately.
Perhaps he is betting against the United States, but the fact that our debt will never be paid back, nor could be, has nothing to do with it, as this has been common knowledge all along with anyone with a clue of how fiscal policy works. When you spend more than you borrow, and this spending includes interest payments, you go more and more in debt over time. You get to the point where you simply cannot pay it back because the cost of interest alone plays too big of a role even in the most austere of budgets, and even the ones that sends everyone demonstrating in the streets is not even close to being enough.
We can put the idea of repaying federal debt, and any other kind of government debt for that matter, to bed, because the idea simply wasn’t ever born. That’s just not the intention, that’s not at all how these things work.
We do not mind Buffett reminding people of this though and applaud his effort, and the fact that Denning, who is supposed to be some sort of expert on finance given his job is to write about these topics, needed to be told this does suggest that Warren does need to spread the word about this. We hope Buffett did not just come to this realization, and based upon what he said next, we’re not sure.
Buffett next shared the revelation that thinking that the U.S. government could ever default on its debt is “laughable,” and the trick is for them to just keep “borrowing in your own currency.” While it is true that this is what they do, the fact that he used the term “borrowing” should tip Buffett off, insofar as if this money does need to be borrowed, it needs to borrow from someone, just like we borrow when we want to buy something we cannot afford.
This requires real people to lend real money to the U.S. government, and this is covered by the U.S. Treasury for Kids site what we checked out. It warmed our hearts to see this being explained by our government to our children, and of course they aren’t out to expose the dark side of this, but just the fact that they are telling kids that they need to borrow this is a big step forward over how just about all adults understand this, including our friend Denning.
Denning tells us that Buffett is right because we can just print all the money we need, so his understanding is way off and doesn’t even include the borrowing part, even though Buffett just mentioned the word in his explanation. Both men have made a real mistake here, one thinking that we can just print money and the other believing that we do need to borrow but can borrow unlimited amounts.
If a financial writer and even the most famous investor of all time can misunderstand this, imagine how many others fail to realize what really goes on when the U.S. Treasury raises money. They may notice that the government shuts down from time to time when they have to raise the debt ceiling, which must be passed by Congress, so this is indeed real borrowing. If this were about printing money, they aren’t asking to print more, and when you print more you don’t borrow, and the word would not even be used in this case.
If Congress needs to set a ceiling, perhaps there is another ceiling out there. The ceiling that Congress uses is the one that we can’t go over as far as requesting funds, but perhaps there is another ceiling, where we have Congressional permission but the people we borrow this very cheap money from runs out of money that they wish to lend us this cheaply.
Some Things Are Too Important to Misunderstand
At any given point in time, there is an amount that people can use to buy the debt instruments that the U.S. Treasury issues, appropriately called treasuries. Countries issue sovereign bonds, debt that they issue that gets bought by the public with the U.S. government promising to pay both interest payments as well as paying back the principal at the appointed time, where if you buy a 10 year treasury, you get your money back in 10 years.
Treasuries do get refinanced as they mature, as Warren has figured out, which means that they issue another treasury and take the proceeds of that one to pay off the principal of the one that just came due. This in itself isn’t a concern, unless you thought that the intention was for the government to pay back this debt, that the loans they take out are short-term like 1 year, 10 years, even 30 years.
We need to look at how the national debt is growing exponentially to see the real potential problem. This all started back in 1791, where the very young U.S. government borrowed $75 million. For the next 70 years, the national debt was kept well in check, keeping it under $128 million the whole time, and even almost paying it off one year.
Then came the civil war, and within two years, we went from $90 million to over a billion. The next big leap was during World War I, going from about $3 billion to $27 billion. World War II took us from $42 billion to $269 billion. Wars are expensive and require a lot of extra borrowing.
The debt grew slowly but steadily over the next 40 years, finally passing the trillion mark in 1982. Once the first trillion was on the books, they started coming faster and faster. They are really coming fast now, passing the $22 trillion mark at the end of 2019, with all the extra borrowing this year yet to be added. We’ll be at least at $26 trillion by the end of the year, depending on how much more we borrow.
If Buffett lived 200 years ago, perhaps his revelation that we are not going to pay this back should attract some attention, as the debt was kept manageable enough back then that we probably could have gotten it down to zero if we wished, but a very long time has passed since we could have entertained such a possibility.
Now, it’s a matter of watching the debt grow parabolically, and as we draw how this chart will play out in the future, if you think that it is laughable that the United States will default like some other countries already have, the joke would be on you if it were a joke.
What this comes down to is that the need for the U.S. government to borrow is growing faster than the growth of people’s ability to lend to them, and unless we slow down this rate of borrowing, we will eventually exhaust this supply of money. This is not hundreds of years away as some may think. No one is exactly sure of how long we’ll be able to keep this Ponzi scheme up, but we do know that greatly accelerating our borrowing the way we have this year, and continuing to accelerate if the way that the Democrats want to, will get us to economic doomsday all the faster.
Buffett has also shared his confusion about how exploding debt and negative interest rates are interacting, although these are two very different phenomenon. The lower the interest rates that you have to pay, the better, and the fact that interest rates are so low provides a reprieve. This is indicative of a healthy supply right now of funds that can be lent out, but these rates cannot stay low forever.
As they rise, this will balloon the debt servicing costs of our ballooning debt, and when both balloons blow up at the same time, the combination will cause rates to go up even more, as higher rates impact a country’s ability to repay, it negatively impacts its creditworthiness in other words.
This is similar to someone going more and more into debt and seeing their credit rating decline and the amount that it costs to borrow more go up. We do not have to fear negative interest rates, we need to fear the opposite. Anyone who feels that the rates are too low won’t lend the money, and we could not agree more with Buffett that treasuries are terrible investments, but they are terrible due to their pathetically low return, too low for even Warren Buffett, whose bar is pretty low but still higher than this.
Denning tells us that Buffett getting more into gold now is a bet against the United States, which may have some truth in it, but we do need to be clear that this may be a bet not against the country but against the currency losing value. The dollar has been in decline and the crazy spending of 2020 and the prospects of a political party simply gone mad accelerating this even further does weigh in on this, but most of this has to do with the recession and not how things will blow up some day.
Denning then tries to explain to us how bad negative interest rates are for average folks, where it is supposed to cost us money to store our money. This is purely amateur hour, as while Buffett could stand to brush up on his economics, Denning is completely lost in this discussion.
No one has to pay to store their money and this idea is indeed as ridiculous as it sounds. There is a huge difference between negatively yielding bonds and paying to store your money, and people can lose money on sovereign bonds as they can with any investment, but banks aren’t going to charge you interest for keeping money on deposit, which is actually ludicrous.
Banks make money from your money, and compete for it, and while the rates they may pay may be near zero, they don’t go below it. If banks started doing this, there would still be banks that would be more than happy to hold it for you for nothing, because they make money off the money you let them hold for you.
The rates on bonds don’t go negative either, and no one pays the government for the privilege of lending them money the same way that you would pay a negative rate at a bank, as they always pay some sort of positive interest rate. As they are traded though, traders can speculate on their price, paying more than the maturity value of it and enough that the rate of return on the investment turns negative.
They do this because there are times where you can make quite a bit of money when the demand for bonds goes up enough. The money made here is by way of capital gains, where you buy a bond, rising demand puts its market price up, and you sell it at a higher price, the same thing that people do when they speculate on stocks.
We Need to Think About What We Are Saying More
It is not that there are not concerns with negative yielding bonds, as this has them functioning as hot potatoes eventually, where someone will lose a bunch of money on them. An easy way to understand this is if we have a bond that is worth $1000 at maturity and it is being traded at $1200, at some point in time, someone has to take this 20% loss. At the very least, as the bond approaches maturity, this money will evaporate, not from market forces but just by way of simple math. Even if the last trade of this potato was over the $1000, it’s going to that price on maturity day, like it or not, because that’s the payout.
The United States has been able to avoid negative yields up until now, and even with our losing our minds over COVID-19, the Fed sees this sort of thing as a last resort, and remains firm in opposing such a thing.
Unless you own sovereign bonds, none of this should matter to you anyway, and if you do own them, and don’t feel so great about the idea, you can always sell them. Denning’s way of portraying this is simply rabble-rousing based upon misunderstanding.
Denning’s next item he shares with us is even more rabble-rousing, where high-frequency trading programs are alleged to be stealing money from individual investors. There are actually people out there who worry about these things, with Denning among them, even though this is absolutely ridiculous.
High frequency traders do not compete with investors or even human traders, as these trades are on a timeframe of thousandths of a second, which are no more comparable to even higher frequency human traders than these human traders compare to long-term investors.
If we imagine everyone only trading long term, we’d have a much more illiquid market and the spreads between the bid and offer would be much larger. Trading on a higher frequency than yours only makes things better for you, and the more frequency there is overall, the more efficient the market is.
High frequency trading programs fighting over extremely tiny amounts on extremely tiny timeframes narrows spreads, and everyone pays the spread, even investors. To suggest that high frequency traders somehow take money from us is just crazy. People make or lose money based upon how the price of the asset changes, where it is the movement of the line itself that matters, not zigs and zags along the way that are not even perceivable to the naked eye.
Denning tells us that they do this to us by having better data on predicting our behavior. High frequency trading isn’t concerned with any of this, as their predictions only cover microseconds, but trading programs do this, but their existence also helps us.
Trend-following trading programs look to capture price trends, just like human traders do, and even investors seek to follow trends, even though their trends are measured over much longer periods. These programs serve to prolong trends, and upward pressure being placed this way helps everyone by making the value of our positions go up.
Denning next speaks of the prospects of a stock market bubble bursting, and while he has concerns, and mentions George Soros’ fear of what happens when the Fed’s friendship to the markets wanes, but Soros wasn’t talking about a bubble bursting, he is worried about things moving the wrong way in a more modest fashion.
If you expect prices to go down, it’s only natural to want to avoid this, and it takes far less than the potential for a crash to scare some of us away. While we share some of Soros’ concerns, we feel that he is being too pre-emptive, even though he must be to some extent because you don’t get out of positions the size of Soros’ at the drop of a hat.
We are much more afraid of the election crashing the party than the Fed doing it, and the Fed will be completely on board for a while, although the amount that our government is on board with us is yet to be decided, and there could be dramatic changes coming.
Denning then really gets technical when he speaks of the lower velocity of money that we see right now will have a rebound inflationary effect. This basically is saying that people are saving more so when they spend it, this will be inflationary. If that’s the way it ends up happening, this could cause a spike in inflation, but there isn’t any good reason to think that it will, that people will change their mind so quickly and decide to spend a lot more. This change was inspired by recent events and will not so soon be forgotten.
We’re thankful for seeing such a hodgepodge of misunderstanding all in one place, which has allowed us to speak about several ways that people understand matters related to economics and government. Just like Ron Paul has tried to rile everyone up over going back to the gold standard, and demonstrating such a poor understanding of the issues, a little knowledge but not enough can have us willfully increasing the level of misunderstanding we have.
This speaks very loudly for the real need for more financial education among the public, which even includes icons such as Warren Buffett it would seem. In a democracy, with so much at stake with these issues, we need to be in a position to make informed decisions, not ones based upon a lack and sometimes complete lack of understanding of what we are deciding on.
The U.S. Treasury can and will eventually default. Negative yields only matter to those who trade these instruments, but the lower the interest rate is that governments need to pay, the better it is for the country. High frequency trading helps, not harms us, as does any additional trading. The stock market may be in trouble but the big risk these days is political, not economic.
We at least need to insist that those who we trust to govern us at least be in the know, but if the people aren’t in the know themselves, they won’t be able to tell. It is time to start being able to tell.