Why the Debt Madness Makes Sense, at Least for Now

I think I finally get it.

With the U.S. government set to issue an additional $1.2 trillion in U.S. Treasuries this year to help finance its budget deficit and with many economists saying that our total national debt is out of control, the U.S. government is paying very little in terms of interest on its ballooning debt.

Because big U.S. corporations are still worried about the economy, they are sitting on a hoard of cash. Depending on what report you read and believe, the S&P 500 companies are sitting on just over $2.0 trillion in cash and have slashed their borrowing.

The mood of U.S consumers has also changed. Instead of being borrowers, they are becoming savers. I thought I would never see the day when Americans stopped spending and started saving, but that day is here.


In September 2005, I wrote in these pages of how the U.S. savings rate had reached zero. Throw in one heck of a recession, and what happens? Americans stop spending and start saving. I’m pleased to see that the U.S. savings rate is above six percent today.

But if U.S. companies are sitting on big cash and not borrowing, and American consumers are saving and not spending, who is borrowing money? The U.S. government, of course.

Hence, lack of demand for loans from banks and consumers has pushed rates on Treasuries down to record lows. And our government is taking advantage of interest rates that are low to finance the big deficit it has created to jump start the economy.

Last week, the U.S. government sold about $30.0 trillion in three- year Treasuries at an interest rate of only 0.84%. Yields on 10-year Treasuries are now well below three percent.

I guess if was running Washington, I’d think we need to create jobs to get Americans back to work; we cannot risk a double-dip recession. And, with interest rates so ridiculously low, let’s borrow to our hearts’ content to get this economy going again. And I think that’s exactly what is happening.

But all good things need to come to an end. The piper eventually needs to be paid. Will it be rapid inflation that eventually pushes interest rates back up? Will it be a devaluing U.S. dollar that will push rates up? Or will the economy simply improve to the point that businesses start borrowing again, thus pushing interest rates up?

Right now, income investors, with the trillions of dollars sitting in bond and fixed income funds, have little choice but to buy U.S.
Treasuries. Big demand for Treasuries continues to push interest rates on those treasuries down.

How will this all end?

We are sailing into waters we have never been before.
Unfortunately, I do not believe that the story of the U.S. government issuing huge amounts of debt at interest rates that are ridiculously low will end well at all.

Michael’s Personal Notes:

Below, we’ve started to add to PROFIT CONFIDENTIAL our estimate on what the stocks that make up the Dow Jones 30 Industrial companies will earn this year, what price/earnings multiple those earnings will translate into, and the dividend yield. We then relate those numbers to the stock market’s current price level. You can check these numbers daily now at www.profitconfidential.com.

Where the Market Stands:

Here are this week’s opening numbers:

— We expect the Dow companies to earn a total of $740.00 per share this year (total earnings per share for the 30 stocks).
— Translated price/earnings ratio is under 14. Dividend yield is 2.7%.

The Dow Jones Industrial Average opens this morning at 10,303.15, down 1.2% for 2010. I see the market continuing the bear market rally that started on March 9, 2009.

At a dividend yield of 2.7%, and given that 30 U.S. T-bills pay only 0.15%, the market is far from overpriced. The bellwether 10-year treasury only pays 2.66%.

What He Said:

“Any way you look at it; the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second, and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in PROFIT CONFIDENTIAL, August 27, 2007. “As for the stock market, it continues along its merry way, oblivious to what is happening to homebuyers’ wealth. [Since 2005, I have been writing about how the real estate bust would be bigger than the boom.] In 1927, the real estate market crashed and the stock market, even back then, carried along its merry way for two more years until it eventually crashed.
History has a way of repeating itself.” Michael Lombardi in PROFIT CONFIDENTIAL, November 21, 2007. Dire predictions that came true.