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Wednesday, September 25, 2013

The Fed's 'hidden agenda' behind money-printing

The markets were
surprised when the Federal Reserve did not announce a tapering of the
quantitative easing bond buying program at its September meeting. 
Indeed, its signal to the market that it was keeping interest rates low
was welcome, but there may be a hidden agenda. 
Since it began in late 2008, QE has spurred a vigorous debate about its merits, both positive and negative. 
On the positive side, the easy money and low interest rates resulting from quantitative easing have been a shot in the arm to the economy, fueling the stock market and helping the housing recovery.  On the negative side, The Fed
accomplished QE by "printing money" to buy Treasurys, and through the
massive power of its purchases drove interest rates to record lows. 
But
in the process, the Fed accumulated an unprecedented balance sheet of
more than $3.6 trillion which needs to go somewhere, someday. 
But we know all this. 
I
believe that one of the most important reasons the Fed is determined to
keep interest rates low is one that is rarely talked about, and which
comprises a dark economic foreboding that should frighten us all. 

Gartman: Leave tapering to next Fed group

The economy is stronger than
it looks, said Dennis Gartman, The Gartman Letter, sharing his outlook
on gold, the next Fed chairman and the fate of Treasury rates. 

(Read more: Fed assertion of 'tight' conditions looks shaky)
Let me start with a question: How would you feel if you knew that
almost all of the money you pay in personal income tax went to pay just
one bill, the interest on the debt?  Chances are, you and millions of
Americans would find that completely unacceptable and indeed they
should. 
But that is where we may be heading. 

Thanks to the Fed, the interest rate paid on our national debt is at an
historic low of 2.4 percent, according to the Congressional Budget
Office. 
Given the U.S.'s huge accumulated deficit, this low interest rate is important to keep debt servicing costs down. 
But isn't it fair to ask what the interest cost of our debt would be
if interest rates returned to a more normal level?  What's a normal
level?  How about the average interest rate the Treasury paid on U.S.
debt over the last 20 years? 
(Read more: Fed in 'monetary roach motel,' won't taper: Schiff)
That rate is 5.7percent, not extravagantly high at all by historic standards. 
So here's where it gets scary: U.S. debt held by the public today is
about $12 trillion.  The budget deficit projections are going down, true,
but the United States is still incurring an annual budget deficit by
spending more than we take in in taxes and revenue. 
The CBO
estimates that by 2020 total debt held by the public will be $16.6
trillion as a result of the rising accumulated debt. 
Do the
math: If we were to pay an average interest rate on our debt of 5.7
percent, rather than the 2.4 percent we pay today, in 2020 our debt
service cost will be about $930 billion. 
Now compare that to the amount the Internal Revenue Service collects from us in personal income taxes. 
In 2012, that amount was $1.1 trillion, meaning that if interest rates
went back to a more normal level of, say, 5.7 percent, 85 percent of
all personal income taxes collected would go to servicing the debt.  No
wonder the Fed is worried. 
Some economists will also suggest
that interest rates may go much higher than 5.7 percent largely as a
result of the massive QE exercise of printing money at an unprecedented
rate.  We just don't know what the effect of all this will be but many
economists warn that it can only result in inflation down the road. 

(Read more: Did the Fed just pop the stock market bubble?) 
As of today, interest rates are rising, and if this is a turning point, it is a major one. 
Rates
in the U.S. peaked in 1980 (remember the 14 percent Treasury bonds?)  so
if we are at the point of reversing a 33-year downward trend, who wants
to predict how this will affect the economy? 
One thing is
clear: Based on CBO projections, if interest rates just rise to their
20-year average, we will have an untenable, unacceptable interest rate
bill whose beneficiaries are China, Japan, and others who own our bonds. 
And if Americans find out that the lion's share of their
income tax payments are going to service the debt, prepare for a new
American revolution. 

Peter J. Tanous is
president of Lepercq Lynx Investment Advisory in Washington D.C. He is
the co-author (with Arthur Laffer and Stephen Moore) of The End of Prosperity (2008), and co-author (with CNBC.com's Jeff Cox) of Debt, Deficits, and the Demise of the American Economy (2011). 

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