$10 Trillion in New Treasuries will be Issued this Year

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Episode Transcript

Speaker 1 (00:00):
If you've been watching headlines lately, you'd be forgiven for
thinking that the worst of the bond bear market is over.
Treasuries have been rallying recently. Interest rates for bonds have
been dropping. The market is pricing in rate cuts by
the Fed, and it seems like the only question is
when will they cut rates and how many times will

(00:21):
they cut rates. So the reality is the carnage in
the bond markets has just begun, and we are far
more likely in for many more years of higher rates
and higher inflation. And the US treasury market is about
to take another big hit. And the most urgent thing
that is happening in the short term for investors to
watch out for is the unwind of hedge funds trading

(00:44):
treasuries in what is called the basis trade. As of
right now, hedge funds are responsible for providing the necessary
liquidity in the US treasury market. This is because trading
firms have been engaged in something called the basis trade
for a couple of years now. This trade has been growing,
and it is a type of relative value trade in

(01:04):
which you buy one thing and you short another thing.
Those two things would be almost identical in terms of
their structure, but they would vary slightly in their price.
By buying one and shorting another, it gives you the
ability to take advantage of the difference in those prices,
and through leverage and repeating this trade many, many, many times,
you can make risk free money. Now, if your spidy

(01:26):
sense goes off whenever you hear the words risk free money,
then that means you're doing something right. Because there's no
such thing as the elimination of risk. You can only
transfer risk. And while these trading firms have been providing
a necessary service by providing liquidity for US treasuries, because
they are buying and selling so many of these, there's

(01:48):
no escaping the fact that this has built up a
ton of risk in the financial system by using so
much leverage. It is also true that when you try
to impose regulations to tamp down on that rich that
has already been built up, more often than not you
cause the very unwind you were trying to prevent in
the first place. More than likely, this is not going

(02:09):
to result in anything crazy like an overnight collapse of
the entire financial system, But what this is likely to
do is put more and more stress on an already
stressed treasury market by removing liquidity. And as we are
about to see, twenty twenty four is not exactly the
year in which you want to be removing liquidity from

(02:29):
the US treasury market, because this year the US government
is going to have to issue about ten trillion dollars
in new treasuries. You read that right, ten trillion dollars
in new treasury issuance just this year alone. Now, that
doesn't mean the national debt will be going up by
ten trillion dollars. So let's break this down. We've got

(02:51):
new borrowing and borrowing to replace old, existing debt. The
deficit for twenty twenty four is projected to be about
one point four trillion dollars. Remember, the deficit for the
US government is the difference between what they spend and
what they take in taxes. So if all goes according
to plan during this year, they will borrow an additional

(03:12):
one point four trillion dollars in order to cover the
difference between what they take in taxes and what they spend.
But one point four trillion dollars is a far cry
from ten trillion dollars. So where is the other money
coming from? Over the course of twenty twenty four, we
have about eight point nine trillion dollars worth of government
debt that is going to be maturing. This means when

(03:34):
you look at the total national debt of thirty four
trillion dollars, almost nine trillion of that is coming due
this year. We know they don't take enough in taxes
in order to be able to pay off that old debt,
which means they have to borrow new debt in order
to pay off that old debt. To put this into perspective,
that means that even if the government this year didn't

(03:58):
borrow anything extra and they ran a zero dollar deficit,
meaning every dollar they spent was not borrowed, but it
was taxed, and they didn't borrow it or spend any extra,
they would still need to borrow eight point nine trillion
dollars just to pay off eight point nine trillion dollars
that is due to get paid off. So when we

(04:18):
take the eight point nine trillion dollar debt that has
to be borrowed just to pay off maturing debt, and
add on top of that the one point four trillion
dollars in new debt that has to be borrowed to
cover the difference, between what they're spending and what they're taxing.
Just this year, it means the US government will be
borrowing ten trillion dollars plus just this year alone. It

(04:41):
is true that United States government bond interest rates dropped
over the end of twenty twenty three, but looking at
the longer term trend and considering how much more they're
going to have to continue to borrow into the near future,
it is almost a certainty that rates go up from here.
That is true whether we're looking at short term debt
like the two or whether we're looking at something in

(05:02):
the middle like the ten year, or long term debt
like the thirty year. And this is of course, assuming
that there's no recession this year or no unexpected spending
that the government has to do, because if there's a
financial crisis, if there's a banking collapse, if there is
a recession, usually what happens is tax revenues plummet, which
means they have to borrow even more to spend just

(05:25):
what they are planning on spending, and even more than that,
if they plan on spending even more. Now, very few
people take a look at the situation and think, oh,
this is sustainable, this can just continue forever. So where
does this leave us over the next five years, over
the next ten years, Well, counterintuitively, we are likely going
to see two things that look like they can't exist

(05:45):
at the same time. Number one, we're going to see
the Federal Reserve cut rates and return to quantitative easing.
On the other hand, we're actually going to see higher
interest rates and higher inflation for everybody. So how does
that work. This is a chart of the Federal Reserve's
balance sheet, which has been declining ever since it peaked
in April of twenty twenty two. If we continue on
the current pace, eventually the government will need to borrow

(06:07):
more money. Then they'll be able to actually borrow either
because there won't be enough dollars available to lend to
the government, or because their expenses will be so high
that they'll just be broken. They won't be able to
borrow enough. But obviously it won't come to this. The
Fed's balance sheet here, instead of moving down, we'll start
moving back up again. The Federal Reserve is the central bank,
and when they buy assets, they're primarily buying US treasuries

(06:31):
from the open market, buying treasuries like the thirty year
or the ten year from banks. What banks do with
this cash most often is they turn around and lend
that new cash back to the US government by buying
a new treasure. In this way, banks operate as the
middlemen between the Federal Reserve and the federal government. So
when the Fed's balance sheet goes up from something called

(06:52):
quantitative easing, even though banks are in the middle of
this process, it essentially means the Federal Reserve is printing
money money, loaning it to the federal government, and then
the federal government owes those dollars back to the FED.
This is a way for the government to get cheaper
debt because they're able to borrow at lower rates when
the Federal Reserve is doing this. Most often, quantitative easing

(07:16):
like this is also happening during times or the Federal
Reserve lowers the Federal funds rate. Now, I said before
that this would likely result in higher rates for everybody.
So if the Federal Reserve is lowering rates, why would
that mean higher rates for people like you and I?
So far, in the air of twenty twenty four, the
US government has spent one point six trillion dollars five
hundred billion dollars of that has been borrowed. But this

(07:39):
is happening while interest rates are historically hot, and the
longer interest rates for the government stay high, the more
expensive that spending becomes for them. But if the Federal
Reserve steps in and starts printing money to loan to
the government again, then that borrowing for the government actually
gets cheaper. As the cost of borrowing goes down for
the government, it makes spending more cheaper and cheaper as

(08:00):
the government is able to spend more and more from
borrowing money that's been printed into existence by the Federal Reserve.
What do you think that does to prices? It pushes
them up, which means a return to more inflation. And
for anybody who cannot borrow directly from the Federal Reserve,
it means you're borrowing from private lenders who actually care

(08:22):
about getting a profit on their money, which means that
when inflation continues to move higher from the increased spending,
private lenders like mortgage lenders, auto loan lenders, credit card
interest rates are all going to be moving higher in
order to compensate for the increased inflation. Just to put
it very simply, when the Fed lowers rates and restarts

(08:42):
QI as a way to make sure the government doesn't default.
It will mean that the government can actually borrow and
spend more. As the government borrows and spends more, they're
actually spending money that has been printed into existence. All
that new money pushes prices higher as inflation soares yet
again again. Private lenders for forms of debt like mortgages

(09:02):
and auto loans and credit cards will demand higher and
higher interest rates so that they're not getting burned on
their purchasing power, and those interest rates will go high.
This is in line with the forty year debt cycle
which started in nineteen forty, with inflation and interest rates
moving higher for forty years until nineteen eighty until they
peaked out when the next phase of the debt cycle
started and interest rates and inflation started moving lower for

(09:26):
the next forty years until they bottomed out again in
twenty twenty, again forty years later, which means we have
now started the next phase of the long term debt
cycle with inflation and interest rates moving higher yet again.
This lines up with the long term US debt to
GDP cycle as well, with the early forties showing the
US debt to GDP ratio peaking at about one hundred

(09:48):
twenty percent and then moving down for the next forty years,
bottoming in nineteen eighty at around thirty one percent. For
forty years after that, the debt to GDP ratio rose
yet again, peaking again around one hundred and twenty percent,
which means another deleveraging is do which only happens through
deflation as a death spiral, or through inflation. And if

(10:11):
the first couple years of this phase that started in
twenty twenty are any sign, we know that the people
who are in power are going to choose the inflationary
route again like they did the last time. So buckle up.
Interest rates are moving higher. Even if we do experience
a short term drop, treasuries will continue their move down
and inflation will be going up for longer as well.
Like I said earlier, you cannot eliminate risk. You can

(10:33):
only transfer risk. But the nice thing is in financial
markets there are unlimited ways to transfer risk away from
your portfolio. If you do not know how to head
yourself and protect your portfolio from the risks of inflation,
of deflation of market crashes, then you are susceptible and
you may be in the position of the average person

(10:55):
that has to wait years, sometimes decades, for markets to recover.
It happened to the S and P five hundred just
twenty years ago, where the market peaked in two thousand
and didn't recover until twenty thirteen. It happened again in
the seventies, and it also happened in the thirties. It
also happened most famously when the market peaked before the
Great Depression in nineteen twenty nine and didn't make a
new high until nineteen fifty four. Fortunately, with a little

(11:18):
bit of financial education, anybody can learn how to protect
their portfolios from inflation, from deflation, from rates moving up,
rates moving down, from market crashes, being able to hedge
their portfolios and their positions, and not having to wait
and just hope that someday it will come back. And
if you like my help with that, join Heresy Financial University,
linked is in the description below. As always, thanks so
much for watching, have a great day.