If I'm remembering long-ago reading on the topic, 5% is near the point at which interest service on debts exceeds all government revenue (once enough of bonds have turned over at this interest rate to actually be the effective rate being paid out on the population of 10-year T-bills.)
What is the way to interpret this situation as other than a 10 year countdown to chaos? Hope that we reign in spending in a drastic, unprecedented way (without impacting revenue as well...)? From where I'm sitting, once the debt service exceeds revenue, we'll have to get in a big war, destabilize domestic affairs with tax hikes (which are unlikely to work, based on Laffer curve), or cease to pretend that the US currency is a stable trading platform. I guess the third option seems alright for the rest of the world, except no one else's seems to be particularly appealing.
> What is the way to interpret this situation as other than a 10 year countdown to chaos?
Officials sadly have realized that they have a solution to everything: inflation.
What is really hilarious is that it's officially to "combat inflation" but their only way out is inflation because they're never ever repaying that debt.
> cease to pretend that the US currency is a stable trading platform
It is toilet paper. But so is the EUR / JPY / etc.
Aside from the fact that the Laffer curve has never been proven accurate in the U.S. based on actual empirical data, it can be proven trivially false, because it implies the closer your tax rate gets to 0 the more tax receipts you will have. So you’re gonna get far more tax receipts at a 0.0001% interest rate than at a 10% interest rate, which would require a GDP at 0.0001% which would be beyond any actual possibility.
The “Kansas Experiment”, built upon the Laffer Curve idea would indicate it is not worth much[0]. There is of course, lots of conservative discourse on why it failed (not extreme enough, just needed to go longer, etc)
>From where I'm sitting, once the debt service exceeds revenue, we'll have to get in a big war, destabilize domestic affairs with tax hikes (which are unlikely to work, based on Laffer curve), or cease to pretend that the US currency is a stable trading platform. I guess the third option seems alright for the rest of the world, except no one else's seems to be particularly appealing.
...or we just change the price of a dollar. It's good to be the king.
I'm not informed enough on the topic to speak anything near authoritatively but there was an essay posted here ~6(?) months ago that spoke about how >2-3% inflation effectively serves as a means of effectively reducing government debt.
I would imagine your 5% number has to assume some baseline of inflation and that 5% would increase as inflation increases beyond said baseline.
Everyone has an opinion on the optimal part of the Laffer curve.
Evidence may even exist for some of these claims, but we've all got an obvious clear incentive to want lower taxes today while downplaying the long-term risks of the government failing to invest in the future, so I tend to assume we can sustain higher taxes more easily than the loudest voices[0] tell me.
[0] Unless those voices are literally, non-pejoratively, Communists; but even then that's not because they're wrong about the Laffer curve itself, but that the people still promoting Communism today tend to also gloss over all the other mistakes made by the historical examples thereof…
> Hope that we reign in spending in a drastic, unprecedented way (without impacting revenue as well...)?
American politicians, deliberately or out of incompetence, use the crisis of the moment and conveniently forego this topic.
I’m convinced the next US administration HAS to do something about this. I don’t see a way that doesn’t involve both spending cuts and raising taxes.
I don’t like discussing politics on HN, but I think this should be deeply concerning for anyone interested in start ups, technology, or innovation. All of our innovation is enabled by having a somewhat functioning democracy, courts, cops, civic culture, where people have the opportunity to critically think about hard problems and innovate, because they’re not worried so much about near term survival.
One effect of this is that stocks historically average about 8% a year. As this gets closer to that number you can expect money from the stock market to start pouring into bonds. Why take risk when you have a guaranteed yield? This will probably drive the market down much further than it has in 2022.
Yes, but taxes on capital gains are much, much lower than taxes on interest. You probably need bond yields to be about 10-12% to be tax equivalent to equities returns.
Using your 401K, you can create tax equivalency between stock and bond returns. But then that creates perverse outcome of putting shorter duration / lower risk assets in your longer duration savings account. Thanks Washington!
> One effect of this is that stocks historically average about 8% a year.
And stocks in rising interest rates environment only average 6.4% a year, not 8%. Here's a study over 13 periods where interest rates rose in the US since 1962 to 2020:
So, indeed, many are now simply doing this: selling (or pausing their buy/DCA) stocks and taking the guaranteed yield.
I typically considered USD/EUR toilet paper but at 5.6% short term I'm now putting some of my money in short term treasuries. And I'm DCA'ing the proceed into stocks.
> This will probably drive the market down much further than it has in 2022.
I remember my family (in the EU) getting 13%+ interest rates on government bonds when I was a kid.
We're "only" at 5.6%: rates have and could again go much higher.
Another effect will be to make the 'buy house/condo in resort town and airbnb the mortgage' less attractive. That game was played when yields were paltry and mortgages cheap.
I am sceptical that this is really bad for the stock market.
Those 5% must come from somewhere.
Either from a growing economy: Good for the stock market.
Or from freshly printed money: Also good for the stock market.
The "risk free" interest rate is not really risk free. You do not get back 2023 Dollars. You get back future Dollars, which are devalued by a currently unknown factor.
As bond rates increased, companies went bankrupt because they couldn't afford loans needed to sustain themselves. When the US Government is willing to pay 10%, 15%, or more on debt, that means that "normies" will have to pay 20% or 25% on mortgages or company credit.
Companies who are used to 8% debt or normal people used to 5% mortgages will suddenly find 15% mortgages or 20%+ debt impossible to manage and go bankrupt. This cascades and hampers the economy.
----------------
Everyone complains about US Government debt while ignoring the fact that most people and companies are levered up the wazoo. You think US Government is bad? How much money is typical Silicon Valley company making, and how much is their debt load?
Will (random-unicorn) be able to survive higher interest rates? Even the fear of others going bankrupt will cause banks to hoard money for themselves (too risky to lend it out to others), especially because cash now earns 5% to 6% safely. Why lend to risky companies who'll just go bankrupt when you can lend to US Government more safely?
In most financial models, the return investors demand on risky assets like stocks depends on the opportunity cost of the risk free rate [eg 1]. As the risk free rate goes up, the return investors expect on risky assets also goes up which pushes their price down.
It's bad for the stock market because the support for equity erodes as capital rotates out of equity and into T-bills & bonds. It also drives up the interest requirements on returns on capital thats loaned out to companies therefore compressing their margins, which in turn puts pressure on their equity. With less money to spend, businesses are more strategic in their capital spend (reducing B2B product purchases).
It also should be mentioned that 5% is actually just above inflation so that yield is nominal and not actual returns. Inflation (Assuming at 3.7% going forward) that 5% is more like 1.3% real return on money.
Worth reminding though the stock market IS NOT the economy.
Over the long term, the yield will uninvert and normalize.
The problem is that we don't know if it will happen with short-term rates dropping, or if long-term rates increasing (or which combination thereof).
If short-term rates remain 5.5%+ like they are today, the yield-curve could normalize with 10Y being at 7% or higher, meaning today's 10Y at 5% would be a bad buy.
Alternatively, if short-term rates drop to 3% and thus 10Y declines to 4.5% (but still normalizes), then buying 10Y at 5% today would be a good idea and better than buying a 10Y later.
A 5% long-term "risk free" rate is roughly equivalent to a company who makes a 'PE Ratio of 20'.
Or in other terms: a $1 Billion company should be making $0.05 Billion (or $50 Million/year) in profits to be comparable to a 10Y bond at 5%. Except... everyone accepts the fact that bonds from the US Treasury (the entity that can literally print US Dollars) is lower-risk than equity from a company. (Equity is junior: if companies go bankrupt they pay their debts first and equity secondly). So you "should" be making more money from equity than bonds/debt for it to make any amount of sense.
Companies will have to change their PE ratios to compete in theory. The easiest way to do this is to... lose valuation. You can't just control profits so easily, so instead of being a $1 Billion company making $50 Million/year, it'd be easier to turn into a $0.5 Billion company making $50 Million/year (now a PE Ratio of 10, or clearly better than Bonds)
Or so the theory of value-investing goes. Which... doesn't really work out in reality but hopefully you get the gist.
-----------
Note that dividends are meaningless from this perspective. Profits are what matters. Companies take profits an invest into themselves, so it doesn't matter if the profits are emitted as dividends (ie: $50 Million returned to the shareholders in a dividend per year), or if the company buys a new $50 million factory each year. Either way, its "the shareholders property" and therefore equivalent.
If the company buys a $50 million factory each year, then in theory, they've grown by $50 million bucks. Ex: the $1 Billion company is now a $1.05 Billion company, and are expected to make $52 Million next year. After all, the "bondholder" could have spent their 5% coupon on buying more bonds, so to be "equivalent" to the risk-free bond strategy, the company also has to grow exponentially.
IE: Everything in the market is now encouraged to grow at 5% (or faster), just to keep up with "risk free government debt".
Debt is continuing to become more and more expensive. Lenders are not lending to people or companies unless the interest rate is much higher than the risk-free 5% offered by the US government.
VCs are not getting funds from LPs who all would much rather invest in US government treasuries for the easy 5%.
Public stocks are often bought with margin money (which is leverage, aka debt). Now, margin money lenders are charging a higher interest rate on that margin, causing borrowers of margin money to not borrow as much. Thus, stocks are not being bid up as much, causing stock prices to drop.
Mortgage rates track the 10-year Treasury yield and thus mortgage loan rates are going higher and higher. Housing market is expected to sag, if not go into a correction or a crash.
For the average person, the only parts that are affected are:
1. If their employer is dependent on cheap money (real estate, VC tech, growth stocks) these employers will either need to innovate HARD or start laying off people under pressure from investors.
2. If you were looking to borrow money for some reason (say, a house or a car), you are looking at insane interest rates.
But all of this happens in any interest rate rise. What is interesting about this particular threshold of 5% is that the world hasn't seen US treasury rates at this level since the last great recession. Most companies, stock holders, people in general don't know how to evaluate this new world of a higher rate. Should you buy that car you desperately need? Is relocation for an RTO job even possible?
Higher interest rates, lower investment rates can have a devastating impact on people's lives.
tl;dr: stocks go down, investors less aggressive, tech job market stays dipped
US Treasury Bonds are considered the risk-free rate.
If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. You'd buy a Treasury bond instead to get 5% risk-free. As a consequence, stock prices should drop until yields + premium to take on risk exceeds the risk-free rate.
I wish there could be an intelligent conversation about this. I feel like whenever I bring it up, i'm immediately mentally labeled a doomer, prepper, or Gingrich era republican, when the way I see it, this is totally apolitical and just 6th grade math.
It's clearly not sustainable to be growing the national debt at 2 or 3 trillion per year, and especially not at 5% interest rates. People bring up Japan as some sort of model that GDP/Debt can go much higher than the US is currently at, while missing that Japan is paying 0.76% on the 10-yr notes today. In many ways, Japan is lucky that their economy is so tepid and impotent because if they had caught the inflation bug like the US, they would have had to raise rates significantly.
Needless to say, debt levels at 270% of GDP with 5% rates would cause a fiscal catastrophe in Japan. Their interest payments alone would exceed all government revenue. They would have to cut 100% of government services (military, medical, pensions, administration, legislation, the courts) AND raise taxes, or issue mountains of new debt in some sort of horrible debt spiral until there was no more demand for yen bonds, at which point there would be sovereign bankruptcy I suppose? IMF bailout of Japan?
At current rates, US government debt will hit $41 trillion this time next year. It grew $604 billion in the last thirty days, and every bond sold is at 5% interest or more. It's just not something that can be done forever unless the US economy starts growing 10-15% per year, or unless rates can be pushed down to 0% indefinitely with no negative consequences.
One thing is for sure, your current tax rate you are paying is as low as it will be for the rest of your lifetime.
It's not unsustainable if that's your question. There's no mechanism that automatically turn this into some clear case of failure.
As a consequence, "what is the solution?" will get sidelined by the question of "should we even solve anything?", even though high interest rates are clearly damaging.
On the actual question of how to solve it, I don't have any answer. Both austerity and inflation come with side-effects that may or may not increase that rate even more.
[+] [-] tbihl|2 years ago|reply
What is the way to interpret this situation as other than a 10 year countdown to chaos? Hope that we reign in spending in a drastic, unprecedented way (without impacting revenue as well...)? From where I'm sitting, once the debt service exceeds revenue, we'll have to get in a big war, destabilize domestic affairs with tax hikes (which are unlikely to work, based on Laffer curve), or cease to pretend that the US currency is a stable trading platform. I guess the third option seems alright for the rest of the world, except no one else's seems to be particularly appealing.
[+] [-] TacticalCoder|2 years ago|reply
Officials sadly have realized that they have a solution to everything: inflation.
What is really hilarious is that it's officially to "combat inflation" but their only way out is inflation because they're never ever repaying that debt.
> cease to pretend that the US currency is a stable trading platform
It is toilet paper. But so is the EUR / JPY / etc.
Wealth is anything that is not that toilet paper.
[+] [-] saalweachter|2 years ago|reply
Doesn't that assume we are currently sitting at the optimal point of the curve? Is there any reason to think that is the case?
[+] [-] addicted|2 years ago|reply
[+] [-] 0cf8612b2e1e|2 years ago|reply
[0] https://en.m.wikipedia.org/wiki/Kansas_experiment
[+] [-] ramesh31|2 years ago|reply
...or we just change the price of a dollar. It's good to be the king.
https://en.wikipedia.org/wiki/Modern_monetary_theory#Governm...
[+] [-] sugarpile|2 years ago|reply
I would imagine your 5% number has to assume some baseline of inflation and that 5% would increase as inflation increases beyond said baseline.
[+] [-] gregshap|2 years ago|reply
[+] [-] ghastmaster|2 years ago|reply
A key thing to note here is that the US government typically holds shorter term notes which have much lower yields than their 10y counterpart.
[+] [-] ben_w|2 years ago|reply
Everyone has an opinion on the optimal part of the Laffer curve.
Evidence may even exist for some of these claims, but we've all got an obvious clear incentive to want lower taxes today while downplaying the long-term risks of the government failing to invest in the future, so I tend to assume we can sustain higher taxes more easily than the loudest voices[0] tell me.
[0] Unless those voices are literally, non-pejoratively, Communists; but even then that's not because they're wrong about the Laffer curve itself, but that the people still promoting Communism today tend to also gloss over all the other mistakes made by the historical examples thereof…
[+] [-] tracer4201|2 years ago|reply
American politicians, deliberately or out of incompetence, use the crisis of the moment and conveniently forego this topic.
I’m convinced the next US administration HAS to do something about this. I don’t see a way that doesn’t involve both spending cuts and raising taxes.
I don’t like discussing politics on HN, but I think this should be deeply concerning for anyone interested in start ups, technology, or innovation. All of our innovation is enabled by having a somewhat functioning democracy, courts, cops, civic culture, where people have the opportunity to critically think about hard problems and innovate, because they’re not worried so much about near term survival.
[+] [-] unknown|2 years ago|reply
[deleted]
[+] [-] marcrosoft|2 years ago|reply
[+] [-] boringg|2 years ago|reply
Equity can evaporate -- unlikely US T will though the politicians certainly are trying.
[+] [-] jgalt212|2 years ago|reply
Using your 401K, you can create tax equivalency between stock and bond returns. But then that creates perverse outcome of putting shorter duration / lower risk assets in your longer duration savings account. Thanks Washington!
[+] [-] TacticalCoder|2 years ago|reply
And stocks in rising interest rates environment only average 6.4% a year, not 8%. Here's a study over 13 periods where interest rates rose in the US since 1962 to 2020:
https://www.lpl.com/newsroom/read/weekly-market-commentary-r...
So, indeed, many are now simply doing this: selling (or pausing their buy/DCA) stocks and taking the guaranteed yield.
I typically considered USD/EUR toilet paper but at 5.6% short term I'm now putting some of my money in short term treasuries. And I'm DCA'ing the proceed into stocks.
> This will probably drive the market down much further than it has in 2022.
I remember my family (in the EU) getting 13%+ interest rates on government bonds when I was a kid.
We're "only" at 5.6%: rates have and could again go much higher.
[+] [-] landemva|2 years ago|reply
[+] [-] esotericimpl|2 years ago|reply
[deleted]
[+] [-] mg|2 years ago|reply
Those 5% must come from somewhere.
Either from a growing economy: Good for the stock market.
Or from freshly printed money: Also good for the stock market.
The "risk free" interest rate is not really risk free. You do not get back 2023 Dollars. You get back future Dollars, which are devalued by a currently unknown factor.
[+] [-] dragontamer|2 years ago|reply
As bond rates increased, companies went bankrupt because they couldn't afford loans needed to sustain themselves. When the US Government is willing to pay 10%, 15%, or more on debt, that means that "normies" will have to pay 20% or 25% on mortgages or company credit.
Companies who are used to 8% debt or normal people used to 5% mortgages will suddenly find 15% mortgages or 20%+ debt impossible to manage and go bankrupt. This cascades and hampers the economy.
----------------
Everyone complains about US Government debt while ignoring the fact that most people and companies are levered up the wazoo. You think US Government is bad? How much money is typical Silicon Valley company making, and how much is their debt load?
Will (random-unicorn) be able to survive higher interest rates? Even the fear of others going bankrupt will cause banks to hoard money for themselves (too risky to lend it out to others), especially because cash now earns 5% to 6% safely. Why lend to risky companies who'll just go bankrupt when you can lend to US Government more safely?
[+] [-] nknealk|2 years ago|reply
[1] https://www.investopedia.com/terms/c/capm.asp
[+] [-] boringg|2 years ago|reply
It also should be mentioned that 5% is actually just above inflation so that yield is nominal and not actual returns. Inflation (Assuming at 3.7% going forward) that 5% is more like 1.3% real return on money.
Worth reminding though the stock market IS NOT the economy.
[+] [-] pid-1|2 years ago|reply
[+] [-] eatsyourtacos|2 years ago|reply
[+] [-] bookofjoe|2 years ago|reply
https://www.wsj.com/finance/investing/five-investors-on-inve...
https://archive.ph/NCv4a
[+] [-] boringg|2 years ago|reply
[+] [-] boringg|2 years ago|reply
[+] [-] dragontamer|2 years ago|reply
The problem is that we don't know if it will happen with short-term rates dropping, or if long-term rates increasing (or which combination thereof).
If short-term rates remain 5.5%+ like they are today, the yield-curve could normalize with 10Y being at 7% or higher, meaning today's 10Y at 5% would be a bad buy.
Alternatively, if short-term rates drop to 3% and thus 10Y declines to 4.5% (but still normalizes), then buying 10Y at 5% today would be a good idea and better than buying a 10Y later.
[+] [-] spaceman_2020|2 years ago|reply
[+] [-] dragontamer|2 years ago|reply
Or in other terms: a $1 Billion company should be making $0.05 Billion (or $50 Million/year) in profits to be comparable to a 10Y bond at 5%. Except... everyone accepts the fact that bonds from the US Treasury (the entity that can literally print US Dollars) is lower-risk than equity from a company. (Equity is junior: if companies go bankrupt they pay their debts first and equity secondly). So you "should" be making more money from equity than bonds/debt for it to make any amount of sense.
Companies will have to change their PE ratios to compete in theory. The easiest way to do this is to... lose valuation. You can't just control profits so easily, so instead of being a $1 Billion company making $50 Million/year, it'd be easier to turn into a $0.5 Billion company making $50 Million/year (now a PE Ratio of 10, or clearly better than Bonds)
Or so the theory of value-investing goes. Which... doesn't really work out in reality but hopefully you get the gist.
-----------
Note that dividends are meaningless from this perspective. Profits are what matters. Companies take profits an invest into themselves, so it doesn't matter if the profits are emitted as dividends (ie: $50 Million returned to the shareholders in a dividend per year), or if the company buys a new $50 million factory each year. Either way, its "the shareholders property" and therefore equivalent.
If the company buys a $50 million factory each year, then in theory, they've grown by $50 million bucks. Ex: the $1 Billion company is now a $1.05 Billion company, and are expected to make $52 Million next year. After all, the "bondholder" could have spent their 5% coupon on buying more bonds, so to be "equivalent" to the risk-free bond strategy, the company also has to grow exponentially.
IE: Everything in the market is now encouraged to grow at 5% (or faster), just to keep up with "risk free government debt".
[+] [-] nine_zeros|2 years ago|reply
VCs are not getting funds from LPs who all would much rather invest in US government treasuries for the easy 5%.
Public stocks are often bought with margin money (which is leverage, aka debt). Now, margin money lenders are charging a higher interest rate on that margin, causing borrowers of margin money to not borrow as much. Thus, stocks are not being bid up as much, causing stock prices to drop.
Mortgage rates track the 10-year Treasury yield and thus mortgage loan rates are going higher and higher. Housing market is expected to sag, if not go into a correction or a crash.
For the average person, the only parts that are affected are:
1. If their employer is dependent on cheap money (real estate, VC tech, growth stocks) these employers will either need to innovate HARD or start laying off people under pressure from investors.
2. If you were looking to borrow money for some reason (say, a house or a car), you are looking at insane interest rates.
But all of this happens in any interest rate rise. What is interesting about this particular threshold of 5% is that the world hasn't seen US treasury rates at this level since the last great recession. Most companies, stock holders, people in general don't know how to evaluate this new world of a higher rate. Should you buy that car you desperately need? Is relocation for an RTO job even possible?
Higher interest rates, lower investment rates can have a devastating impact on people's lives.
[+] [-] deadghost|2 years ago|reply
US Treasury Bonds are considered the risk-free rate.
If you have $TICKER that you expect to yield 5%, you wouldn't buy it because you undertake risk to invest in a company to get 5%. You'd buy a Treasury bond instead to get 5% risk-free. As a consequence, stock prices should drop until yields + premium to take on risk exceeds the risk-free rate.
[+] [-] theanonymousone|2 years ago|reply
[+] [-] naveen99|2 years ago|reply
[+] [-] yeouch|2 years ago|reply
[+] [-] missedthecue|2 years ago|reply
It's clearly not sustainable to be growing the national debt at 2 or 3 trillion per year, and especially not at 5% interest rates. People bring up Japan as some sort of model that GDP/Debt can go much higher than the US is currently at, while missing that Japan is paying 0.76% on the 10-yr notes today. In many ways, Japan is lucky that their economy is so tepid and impotent because if they had caught the inflation bug like the US, they would have had to raise rates significantly.
Needless to say, debt levels at 270% of GDP with 5% rates would cause a fiscal catastrophe in Japan. Their interest payments alone would exceed all government revenue. They would have to cut 100% of government services (military, medical, pensions, administration, legislation, the courts) AND raise taxes, or issue mountains of new debt in some sort of horrible debt spiral until there was no more demand for yen bonds, at which point there would be sovereign bankruptcy I suppose? IMF bailout of Japan?
At current rates, US government debt will hit $41 trillion this time next year. It grew $604 billion in the last thirty days, and every bond sold is at 5% interest or more. It's just not something that can be done forever unless the US economy starts growing 10-15% per year, or unless rates can be pushed down to 0% indefinitely with no negative consequences.
One thing is for sure, your current tax rate you are paying is as low as it will be for the rest of your lifetime.
[+] [-] brad0|2 years ago|reply
This video by Ray Dalio explains it much better than I ever could:
https://www.youtube.com/watch?v=PHe0bXAIuk0
[+] [-] marcosdumay|2 years ago|reply
As a consequence, "what is the solution?" will get sidelined by the question of "should we even solve anything?", even though high interest rates are clearly damaging.
On the actual question of how to solve it, I don't have any answer. Both austerity and inflation come with side-effects that may or may not increase that rate even more.
[+] [-] bookofjoe|2 years ago|reply
tl;dr: You will receive $10,000 in 10 years by investing $6,140 today in the world's safest security.
[+] [-] ericpauley|2 years ago|reply
[+] [-] MuffinFlavored|2 years ago|reply
Invest $6,140 at 3.0% (2% inflation) compounding for 10 years = $8,269.69
Invest $6,140 at 2.5% (2.5% inflation) compounding for 10 years = $7,871.71
Invest $6,140 at 2.0% (3% inflation) compounding for 10 years = $7,491.97
[+] [-] username332211|2 years ago|reply