The $22 Trillion Question – Is the end nigh for the world’s safest investment?

Institutional Investor – by Ben Ruffel

The tone was apocalyptic: “The U.S. federal budget is on an unsustainable path . . . . The scale of the nation’s projected budgetary imbalances is now so large that the risk of severe adverse consequences must be taken very seriously.” The growth in the American federal debt and deficit would soon produce a “fundamental shift in market expectations and a related loss of confidence both at home and abroad,” and the resulting “fiscal and financial disarray” would “depress economic activity much more than the conventional analysis would suggest.” 

These warnings came not from Chicken Little. The white paper was co-authored by Robert Rubin, President Clinton’s Treasury secretary, and Peter Orszag, President Obama’s director of the Office of Management and Budget. If these two were worried, perhaps there was something to worry about.

Yet these words were published in January 2004. Since then, the total public debt outstanding has tripled and the debt-to-gross-domestic-product ratio has more than doubled. Current spending policies have steepened this trajectory: The Treasury Department anticipates $1 trillion deficits starting in 2022 and the Congressional Budget Office forecasts the federal debt relative to GDP to hit its highest level since the end of the Second World War by 2029, and to reach unprecedented territory soon thereafter. Including state and local debts in addition to unfunded pension obligations (all of which the federal government implicitly backstops) increases the total tally of debt outstanding by about 25 percent.

Yet in the shadow of this mounting debt pile, Treasury yields — the compensation investors require for holding these securities — sit at historic lows. President Clinton’s chief strategist James Carville’s wish to be reincarnated as the all-powerful bond market seems as quaint today as Rubin and Orszag’s warnings from 15 years ago. The bond vigilantes have been driven from the land, their homes burnt and fields salted. The bond investor of today instead channels Alfred E. Neuman: “What, me worry?”

The U.S. Treasury market is the largest and most liquid financial market in existence, and it underpins all investments and asset classes. If the Treasury market sneezes, global financial markets, and the world economy, will catch a cold. For stewards of long-term capital, the sustainability of the flood of Treasury issuance cannot be ignored.

The question arises: Are asset allocators worried that the end is nigh for the Treasury market — and should they be?

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