A call to ARMs

National debt surpasses $33 trillion, Treasury yields take off and a nation turns its lonely eyes to the Fed, boo-hoo-hoo...

(Source: Getty Images)

Bill Bonner, reckoning today from Poitou, France...

Now I’ve got plenty of arms
Big arms. Pretty arms.
I got arms up the wazoo.

~ General Rancor, Spy Hard

Today is the big day. The Fed is supposed to begin its “pause”…a prelude, it is widely believed, to cutting rates next year. Nearly 20 years ago, we wrote a book, with Addison Wiggin, in which we saw this coming.

On some dark day in the future, we predicted, “the Fed will panic. In desperation, [the Fed chairman] will point south, toward Argentina. ‘There…that is our only way out,’ he will say.”

That was what is known in meteorology as a ‘long range weather forecast.’ But the range is shortening all the time. And investors are beginning to look for their umbrellas.

Climbing Mt. Debtmore

Here is an item from yesterday’s news, Scripps:

US national debt surpasses $33 trillion for first time     

The U.S. national debt exceeded $33 trillion for the first time ever this week, according to the Treasury Department, surpassing a critical milestone at a time when government spending is in the national spotlight. 

Now, let’s widen the focus. Reuters:

Global debt hits record $307 trillion, debt ratios climb - IIF

Global debt hit a record $307 trillion in the second quarter of the year despite rising interest rates curbing bank credit, with markets such as the United States and Japan driving the rise, the Institute of International Finance (IIF) said on Tuesday.

The financial services trade group said in a report that global debt in dollar terms had risen by $10 trillion in the first half of 2023 and by $100 trillion over the past decade.

The latest increase has lifted the global debt-to-GDP ratio for a second straight quarter to 336%. A slowdown in growth, alongside a deceleration in price increases, have caused nominal GDP to expand less slowly than debt levels and were behind the debt ratio rise, the report said.

And here is another report, which gives us a hint of the Fed’s coming panic, the Washington Examiner:

Treasury yields hit highest since 2007 as markets fret Fed action

Treasury yields have risen in the lead-up to the Federal Reserve’s next interest rate decision this week, with the 10-year yield hitting its highest level in more than a decade.

Benchmark 10-year Treasury yields were sitting at 4.34% on Tuesday, the highest they have been since 2007. Meanwhile, the benchmark two-year Treasury yield was at 5.08%, the highest it has been since 2006, although it was briefly a bit higher in March.

Let’s see. The world’s debt pile is getting higher and higher…as interest rates go up. Somewhere up ahead, the drunk driver meets his brick wall. 

No Way, José

In July of 2020, the yield on a 2-year Treasury bill was 0.11%. Now, over 5%, it is 45 times as high. And if the world’s debt had to be financed at today’s 2-year rate, it would mean annual interest payments of more than $15 trillion – or 17% of world GDP.

Not going to happen. Can’t happen.  

The problem is the ARMs. Last week, the financial world was enchanted by the biggest IPO in 2 years. The Financial Times:

Shares in the chip designer, Arm, jumped as much as 20% as it began trading on the Nasdaq yesterday, valuing the Softbank-backed company at more than $63 billion. 

The company was worth only $32 billion in 2016. Seven years later it added $31 billion in value. How was that possible, given that sales growth and net income actually declined last year?

“We’re more diversified now,” explained the CEO.

This is, of course, no explanation. Diversity may make a company more resilient; it is not likely to make it more profitable. Last year the company had net income around $500 million. At $63 billion, the market is capitalizing the business at 120 times earnings. Or, to put it another way, if you bought the whole business…and things stayed the same…you’d have to wait until year 2,143 to get your money back. Which is a long time to expect things to stay the same in the tech world.  

Yes, some people may still have rotary phones and wear bell bottoms. Long Playing vinyl records are coming back in style. But nobody is getting rich by selling floppy disks or cassette tapes. For every new technology, there is newer technology. And for everyone who makes money betting on it, there are at least 10 old geezers living on Social Security who wished they’d sold earlier.

Things never stay the same. You have to adjust to them. Which is why it is not the short Arm that gets our attention this morning…it’s the long ARMs.  

Printing Press Prosperity

We all know that homeowners would have been better off if, when the gettin’ was good, they had gotten long-term fixed-rate mortgages. They could make their small payments…and wait for the mortgage company to beg them to pay off their loans early. 

An adjustable rate mortgage, on the other hand, in a period of rising interest rates, is murder. Imagine you have a mortgage of $300,000. You got it at 3% – or less than $1,000 per month. Now, it’s 7% – more than twice as much.  

Shorter-term loans are generally cheaper, so much of the world’s debt is short term, and – in effect – adjustable rate. We’ve seen (above) that the official US national debt is over $33 trillion. We’ve also seen that $7.6 trillion of it will need to be adjusted over the next 12 months. Instead of paying 0.11% – as the Treasury did for a 2-year loan in 2020 – it may pay over 5%. A big adjustment. But that’s not all. Not included in the official debt total are obligations for Social Security, veterans’ benefits, disability (NOT including reparations or student loan forgiveness) and other unfunded liabilities that tote to nearly $200 trillion, according to our usually reliable source, MN Gordon at Economic Prism. These liabilities adjust daily. That is, the funds for them must be raised on the open market, as they come due.  

All this adjustable rate debt is like a dental appointment that has been put off for too long. It won’t be much fun, when you finally get in the reclining chair.

We stand by our forecast. As the rates move upward…and businesses, households and the government try to adjust, central banks around the world will panic…and go back to the printing presses.     

Regards,

Bill Bonner