May 12, 2015

A Gigantic Missed Opportunity?

Patrick Marren
Partner

This week may mark the passing of a great national opportunity for the United States.

"It's Not Just Greece, China's Retreat Threatens European Bonds," thunders Bloomberg.

And it's not just China and Greece. "Brexit joins Grexit and bond turmoil to increase investor jitters over Europe," proclaims the Australian Financial Review.

And it's not just Europe and Britain and Greece and China, it's America too: "Bond yields spike, market looks for capitulation," says CNBC.

US bond yields finally seem (possibly) to be headed northward after seven years of historically minute interest rate levels. The quantitative easing actions of the Fed and the worldwide perception of the United States as a haven in a stormy global economic and political picture, among other influences, kept rates low for a very long time. But all things must change, and one day, this state of affairs will as well. That "one day" may be occurring as we speak; or this may just be a false alarm, with distress overseas driving even more money into our Treasuries and holding down interest rates even longer. 

But soon or late, interest rates on U.S. Treasuries will not remain miniscule forever.

Most analysts seem absorbed by the short-term effects of interest rate hikes on stocks and bonds. Being a "futurist," whatever that is, I am more concerned with something else. 

What are U.S. Treasury securities for? We all seem preoccupied by the role they play in what my colleague Robert Avila in 2008 memorably called  "making the mare go," keeping the world economy liquid. It is this role that now dominates discussions of the effects of U.S. government financial policy.

But there is an older purpose for Treasuries, what you might call their "original intent": financing needed expenditures to keep the United States a going concern, politically, militarily, economically. 

Aside from the Obama stimulus of 2009-10, which, though large by historical standards, was judged inadequate in magnitude for its purpose by almost every economist who estimates such things (the economists who opposed the stimulus generally do not believe that any government stimulus can possibly achieve a positive economic outcome), the U.S. federal government has not been allowed by Congress to spend to rebuild its infrastructure, which numerous studies have proclaimed is degrading at an unsustainable rate. The American Society of Civil Engineers (admittedly an interested body) in 2013 gave the infrastructure of the United States a D+ grade. Dams and drinking water and treatment of hazardous waste got Ds. Levees got a D-. Treatment of solid waste led the pack with a B- thanks to recycling and lower volumes. In transportation, aviation got a D (aviation infrastructure received not a cent from the Obama stimulus; think about that next time you are delayed). 

Inland waterways got a D-. Interestingly, inland waterway improvements may be said to be the reason this country exists at all. The Constitutional Convention of 1787 was a followup to a series of meetings on interstate commerce and waterway development called by George Washington as a private citizen in 1785 and 1786 because George wanted to build a canal linking the Potomac River to the Ohio River, where he had a lot of real estate. Now it appears to be less of a priority. So much for "Original Intent of the Founders." 

I could go on, but others have covered this ground, most notably Dr. Rosabeth Moss Kanter in her new book Move: Putting America's Infrastructure Back in the Lead

The point I want to make today is slightly different. It is that infrastructure repair and improvement WILL be done; the only question is WHEN it is done. Airport runways must be resurfaced or air travel stops. Roads have to be repaired or our produce and other products cannot make it to where we are. Bridges must be improved or they will fall down. Air traffic control must be improved or planes will crash. 

So one must ask, when is the correct time to do these projects? And the answer must be: WHEN INTEREST RATES ARE VERY LOW. 

And by that standard, there has never been a better time for us to do infrastructure repair than the past six or seven years. The market has been crying out for the United States to invest in improving its infrastructure. Money from the world over has been begging to be invested in roads, bridges, rail, tunnels, communications, electrical grids, high speed internet, ports, waterways, you name it. 

And because our system of government has more or less ceased to work, these cries have remained unheeded. 

But it gets worse. 

As I said above, we WILL have to spend this money. And we WILL have to borrow that money (because marginal spending WILL be financed) using U.S. Treasuries. But now, thanks to our broken political system, we may have to borrow that money at interest rates several times the magnitude of current ones. 

You may be concerned about "fiscal discipline." I am as well. So you may be interested to learn that if we were to have borrowed $1 trillion for infrastructure investment at the 2.5% 30-year rates prevailing two years ago, we as taxpayers would have had to pay back, over 30 years, a total of about $1.4 trillion. 

If we wait until rates rebound back to a more normal historical rate of, say, 5%, that same trillion dollar necessary investment that WILL be made will cost the American taxpayer about $1.9 trillion. 

If, goddess forbid, rates go up to 8%, a not-crazy assumption, that necessary, inevitable trillion dollar investment over 30 years goes up to $2.6 trillion in taxpayer dollars. 

It gets worse. Because interest rates have been barely above zero in real terms, after you factor in inflation, the actual amount of interest paid by taxpayers had the investment been made in the past six or seven years would be close to zero, because we'd be paying those terrible Chinese lenders back in slightly inflated dollars. Since we're waiting, those Chinese will get ALL of that extra interest - maybe more than doubling the real value of what we initially borrowed. Waiting to invest could increase our real, after-inflation interest payments by a factor of five or ten. 

All of this unnecessary extra expenditure as a result of inflexible politics and lack of vision. These expenditures, again, are not optional. What is optional is waiting to undertake them until bridges begin to collapse, waterways are clogged, planes begin to be grounded or crash, electrical grids go down, and the cost of repair skyrockets because things that could have been simply repaired must now be wholly rebuilt.  And all at a time when the Baby Boom retirements are putting extra pressure on Medicare and Social Security. 

AND we will have the knowledge that we could have done all this inevitable, necessary investment for possibly half the cost in taxpayer dollars and/or debt. While creating jobs that could have funded some of the entitlements being taken out of our hides in 2025 or 2030. 

The Bible speaks of seven lean years and seven fat years. Joseph told the Pharaoh to take a portion of the harvest from the initial seven fat years to prepare for the seven lean years that would follow. Pharaoh did as he was advised, and Egypt was spared starvation.

The United States has had seven lean years, to be sure. But in terms of interest rates, they have been very, very fat years indeed for potential national investment. Those seven fat years will be over, either now or someday in the not too distant future. Congress has not allowed the nation to put aside any of its harvest for the seven lean years to come. The opportunity to do so may now be lost. 

The amazing thing about this is that no one seems to be talking about this historic opportunity that has potentially been squandered just this week. 

We have always had a vision of the future as a nation until very recently. Do we have one anymore? 

Comments  | 

Opportunity lost? For the moment, probably. But the same demand-side forces that are pushing interest rates up will, hopefully, manifest themselves in higher consumption, investment, job creation and...tax revenue. If this virtuous circle is sustainable, the ideological argument against infrastructure spending will be overcome by citizen outrage over transport hazards and inefficiencies, which can only worsen in a growing economy. Interestingly, an apparently bipartisan group of mayors are weighing in on the need for Washington to get behind a long-term plan for infrastructure investment. http://www.nytimes.com/2015/05/13/opinion/let-our-cities-move.html?ref=opinion Unfortunately, as Patrick Marren points out, we've lost our chance to borrow cheaply for these big jobs. We will surely pay more, but in the end it will still be worth it.
pmarren
Mayoral proposals for long-term strategic infrastructure plans we shall always have with us. In an atmosphere where cities usually no longer can swing elections, and unoccupied dirt is overrepresented in our Congress (both in the Constitutionally small-state-heavy Senate and the now scientifically (on both sides) gerrymandered House), any proposal for the benefit of cities will be easily portrayed as a boondoggle for corrupt city grifters. The number of Americans in ex-urbs, on well and septic, detached from the civil engineering grid, unacquainted with public transportation, is probably at an all-time high. So it is at least a plausible scenario for the future that infrastructure gets the absolute minimum investment to keep it from utter collapse, because the expense to bring it up to world-class standards is easily batted down by the now-entrenched anti-government-expenditure blocking minority. We may be in a boiled-frog situation. Bridges have already collapsed, and yet we haven't seen serious money appropriated to remedy the shortfall in bridge maintenance. So we beat on, canal barges against the current, borne back ceaselessly into the crumbling lock.

Thoughts?