United States government has low borrowing costs

Investors looking for “safe” securities have driven down the cost of money for the United States government. The Treasury Department is contemplating whether to issue bonds with a negative interest rate. Many experts have been predicting that this low cost environment is not sustainable. When rates rise, the deficit will balloon without any additional spending.

that’s a complicated way of saying:  In order to raise money to pay for the various programs and services it provides, the United States government, through the Treasury department, sells treasury securities. These securities are bonds where the investor gives money to the government in exchange for a fixed rate of return over a period of time. Today, there is high demand among investors (individuals, foreign governments, banks, corporations, etc.) for these securities because they are believed to be “the safest investment in the world.” Because demand is so high, the Treasury Department is able to offer — and sell — treasury securities which cost the government less and less. To be clear, the “cost” is the amount of interest the government agrees to pay to the investor. Because so many investors want to put their money in government bonds (aka treasury securities) the Treasury Department does not need to offer high interest rates to induce investment.

This low cost environment will not last forever for two reasons. First, when an entity borrows more and more money, the normal market reaction is for the lenders (in this case the investors) to demand an increase in the amount of return. The United States has increased her deficit quite substantially in the past decade. It is close to double the size today. At some point, investors will look at the United States and say to themselves, “I am not confident that they will be able to pay back the money I loan to them.” When that happens, the government will need to induce folks to invest by offering higher rates of return. This increases the cost to borrow. You may remember Standard and Poors downgraded the US debt last summer? This is one indicator that the market is growing concerned about the level of the United States debt and whether the government will be able to pay back all that it owes. If this becomes wide spread, borrowing costs will eventually rise. Second, investor’s risk appetite will increase. Treasury securities are very boring investments. On the day you buy them, you know exactly how much money you will make and the exact day you will make it! In any economic environment, the expected yield on an investment in a treasury security will always be among the lowest of all investment opportunities. Given the market crash in 2008, many investors have taken their money out of the stock market and put it into treasuries. As investors get more comfortable investing in the stock market, there will be less demand for government debt. The Treasury Department, in order to attract investment, will need to offer higher rates of return and, therefore, borrowing costs will eventually rise.

The first reason is debatable. It is likely the government will never default on their debts. But, it is not impossible that investors will get skittish and demand higher returns. The second reason is inevitable. Investors will always cycle between the stock market and the treasury market. The flow of money is constant.

What do higher borrowing costs mean for the government? If something costs the government more, that means there is less money to spend on the programs and services it provides. In other words, higher borrowing costs simply mean the government will either have less money to spend (assuming they are unable to borrow more) or the government will have to borrow even more money to pay their debts and pay for the programs and services. I would bet the government borrows more and that the national debt will creep up even more.