A US Boon in Low-Cost Borrowing
These are the best of times for the world’s most ravenous borrower, the United States of America.
A combination of unusual and unsustainable forces has pushed the cost of borrowing as low as it has ever been, so low that many investors effectively are paying to lend moneyto the government.
Investors buying five-year federal debt are accepting such low interest ratesthat inflationis on pace to reduce the value of their investments by more than 1 percent each year. Yet demand for United States Treasuries remains much greater than the supply.
The glut of cheap money has allowed the government to keep its annual deficits much smaller than it had expected, holding down the growth of the federal debt .
The Treasury Department, seeking to milk the moment, may start issuing debt with negative interest rates, making investors pay for the privilege of lending money to the government.
But a wide range of experts agrees that the bubble will eventually pop. The question, they say, is not if but when. There are signs that the era of low borrowing costs may be approaching its end, as the domestic economy shows signs of strength and Europe pulls back from economic immolation.
“We are in an unusual period right now in which net interest expense is temporarily depressed,” William C. Dudley, president of the Federal Reserve Bank of New York, said in a speech last week. “This will not last.”
People have been predicting that rates will rise ever since the 2008 financial crisis sent investors piling into the safe haven of federal debt, driving down rates.
But what looked like a brief plunge has become a broad trough. The average rates that the government pays to investors in its debt have declined in each of the last five years, from 4.92 percent at the end of 2006 to 2.24 percent at the end of 2011. Rates have edged even lower so far this year. Adjusting for inflation, the government is borrowing at virtually zero cost.
As a result, while the size of the public debt more than doubled over the last five years, from less than $5 trillion to more than $10 trillion, the government’s annual interest payments remained about the same.
In 2006, the bill was $226.6 billion. Last year, the bill was $227.1 billion. The numbers exclude debt held within the government, by the Social Security trust fund, and the cost of interest on those debts.
The danger, Mr. Dudley said last week, is that the current situation may lead some to underestimate the long-term cost of the debt when rates inevitably rise. The administration’s recent budget projects that rates will increase gradually over the next decade, including about 1 percentage point this year. If the increase is just 1 percentage point larger this year, the deficit will grow by $13 billion. If the same higher trajectory holds over 10 years, the additional interest payments would approach $1 trillion.
The basic reason to expect higher rates is that investors usually demand compensation as a borrower’s debts increase. And the government projects that its debt will grow rapidly in coming years.
The ratings agency Standard & Poor’s last year removed some categories of United States debt from its list of the world’s least risky investments, citing its concerns about the ability of the government to contain the growth through cutbacks in planned spending or increases in federal revenue.
So far, however, investors have grown only more clamorous for Treasuries .
The demand reflects the weakness of the domestic economy, and the Federal Reserve’s determined campaign to drive down the cost of borrowing by purchasing more than $1.6 trillion in Treasury securities.
One less obvious benefit is that about 10 percent of federal interest payments are now collected by the central bank, which returns almost all of the money to Treasury because it is required by law to remit its profits.
The United States also has benefited from concerns about the health of European governments. The International Monetary Fundestimates that the benefits of investors fleeing Europe to buy Treasuries have roughly offset any other damage to the American economy from the struggles of the euro zone.
“There’s a good argument that the net impact on the U.S. economy is zero, a little more or less,” the IMF’s chief economist, Olivier Blanchard, said in a recent interview.
All of this has prompted a flight to safety so determined that investors are lining up to accept the near certainty of small losses on Treasuries to avoid the possibility of larger losses on stocks, corporate bonds or the debt of other countries.
This month, when the government auctioned off one-year debt, Treasury agreed to pay 14 cents for every $100 that it borrowed, or 0.14 percent. Last week at the most recent auction of five-year debt, it agreed to pay 88 cents a year for every $100 that it borrowed. At a 2 percent inflation rate, investors would need to be paid $2 for every $100 they lent just to keep pace.
Treasury is now reviewing whether to let prospective lenders offer negative interest rates, meaning that they would pay the government rather than vice versa. It is expected to make a decision by May.
Some economists say they believe rates will remain low for years. David Greenlaw, an economist at Morgan Stanley, forecasts little change through 2013.
“While there have been some bright spots in the data, the economy probably won’t be strongenough to justify rate increases,” Mr. Greenlaw said.
Other economists expect that rates will begin to rise later this year, as the domestic economy improves and fears about Europe abate.
John Ryding, chief economist at RDQ Economics in New York, expects rates on 10-year Treasuries to reach 3.75 percent this year, up from about 2 percent now, as investors awaken from what he described as “extreme risk aversion.”
But he added that he didn’t understand why rates had remained low for this long.
“I have to say that it’s a bit of an enigma,” Mr. Ryding said. “It’s a conundrum.”