When the U.S. borrows money, is the interest rate locked?

[Massacure]

I mean in such a way that if we borrow $1 trillion dollars at 5% and then we raise the interest rates to 6% so we can borrow another $1 trillion, are we paying 5% on $1 trillion + 5% on $1 trillion, or are we paying 6% on $2 trillion?

I'm sorry if I made that a little wordy. I can't think of another way to put it. :(

[NMDemDist2]

1. we finance our debt with Treasury Bonds

how exactly the interest rates are set on those I don't know

but it gives you a place to start :)

[umass1993]

18. the rates are market based

Just as previous posts state. i concur.

[roguevalley]

2. I don't know. I don't speak Chinese.

[elsiesummers]

6. Classic n/t

n/t

[tridim]

3. Honestly I don't know why anyone lends us money

We never pay it back and the debt keeps growing and growing. Any individual who did the same would have been put in prison long ago.

I don't know the answer to your question. Sorry.

[MrUnderhill]

8. We ALWAYS "pay it back".

That's why treasury securities are considered the safest investments in the world (from a credit risk standpoint that is).

It's more like a credit report. It isn't getting down to "0" on your debts that is important... it's that you make all payments as agreed. The US has NEVER defaulted on her bond commitments.

[54anickel]

9. Absolutely! The US has NEVER defaulted....

Just sort of changed the rules on how we pay them back, or "default" by way of "devaluation". :evilgrin:

[MrUnderhill]

10. Can you give an example?

Calling a callable bond is not "changing the rules", and I'm not sure what other examples there might be. Devaluation doesn't seem to fit either... do you mean massive inflation caused intentionally to make the repayment cheaper? If so, I'd say that the 10-12 years have been almost the opposite (historically low inflation rates... even when adjusting for "hidden" inflation). It certainly hasn't been anywhere near as high as most major economies over the same time.

Or perhaps devaluation refers to the recent falling dollar? Rapid moves are always a concern (on both sides), but the dollar is not very far off today from where it has been several times over the last decade or so... and the only people who would be hurt would be foreign investors (IF they bought while the dollar was overly high) and the bulk of our debt isn't held that way.

[54anickel]

11. Was more inclusive of the original post regarding when the US borrows

money on a whole rather than bonds specifically.

The "default" by "devaluation" is more in the historical context and yes, more to do with currency changes.

Changing the rules examples, let's see - we had FDR decree the dollar at $35 per troy ounce devaluing the buck by some 41%. Then there was Nixon changing the rules of the Bretton Woods Agreement by closing the gold window - France certainly considered that a form of default.

Then there was that whole devaluation deal with Sir Ronnie and the Plaza Accord, soon followed by the Louvre agreement. During that mess, Ronnie and Baker were working on yet another valuation proposal thru the IMF, but got distracted by that '87 stock market mishap and that embarrassing Iran-Contra revelation.

The original question covered debts in general. Your post narrowed the discussion specifically to bonds to somehow infer the US never defaults. On bonds, no - not yet, on debts in general, yeah - sort of, but not in the strict legal sense.

[umass1993]

17. but foreign-owned debt is rising rapidly

I guess this is what is troubling many economists. Asian gov't banks are purchasing US Treasuries in massive amount in order to help prop up the dollar. Hence, the fall of the dollar releative to the Euro, because the european banks are not participating in this practice like the asian banks.

Traditionally, foreign-owned debt has been low, but it is growing rapidly. At some point, the asian banks will decide that buying US Treasuries is not in their interest, thus leading to higher US bond rates and a depreciating dollar. Both bad for middle class America, because they buy foreign goods with their dollars, and they pay the bonds with their taxes.

At any rate, foreign-owned debt means that americans will be working for foreigners. whatever money gets sent to them in interest payments can't be spent here on domestic needs.

I'm not sure Dean Baker could have done much better than that...off the top of his head.

[papau]

12. So why does the Bond Dept at PIMCO want to downgrade Treas. to AA?

Seems the likelyhood of a 3rd world like move by the US Treasury in the future where we offer bond holders 50 cents on the dollar has increased per the head guy at PIMCO!

Or at least defacto major devaluation as the euro takes over as the Words reserve currency.

[MrUnderhill]

14. I'd like to read that article. Got a link?

I find it VERY hard to believe. US Treasuries are the DEFINITION of zero credit risk in the investments world. "AA" would be a massive downgrade since they currently score the same as "cash" on a balance sheet (when designated as being held to maturity).

And all bantering aside... there just isn't anything on the horizon that points to that. The debt and/or deficits are nowhere near that level and the US is nowhere near the default level on their balance sheet.

On edit to your edit. The Euro is not going to become the world's reserve currency any time soon. Europe would have to become one political entity and then go through a few decades of stabilization before that could happen. There are just too many divergent governments for it to be a stable replacement for the dollar. Call me again in 30-40 years and we'll consider it.

Have you looked at Germany lately?

[papau]

15. I sent it to you via DU mail

:-)

[54anickel]

19. Not sure if the Euro will become the world's reserve currency in the end

or not. It may be, or it might be used as part of a transition to an entirely different system. Rather than a single currency as the world's reserve used to determine valuations, perhaps it will be based on a basket of currencies or mixture of currencies and commodities - that's what Ronnie and Baker were working on before they were distracted. From what I've read, that was also part of the goal for the creation of the Euro to begin with.

I would be willing to bet that the US$ does NOT have 30-40 years in that position though. I'd give it 5-10 years and that's on the long side.

Here's an article that mentions the WSJ article from Dec 7 regarding the questioning of bonds AAA rating.

http://www.virtualjerusalem.com/news/mediawatch/?disp_feature=x9GWQ0.var

It was also picked up by cbsmarketwatch

http://futures.fxstreet.com/Futures/news/afx/singleNew.asp?menu=latestnews&pv_noticia=1102421359-9e32d306-22959

Makes you wonder if that little WSJ article didn't have something to do with the US$ rally on the following day. :shrug:

[Massacure]

16. Except during the Civil War.

The Confederacy didn't fully pay back it's debts. You can argue that the confederacy doesn't count, however Lincoln refused to recognize it as it's own country.

The subject is a catch-22 really.

[MrUnderhill]

20. Interesting point. But not really correct.

Either the South was or was not a seperate country.... but either way... they were NOT the US Government.

Counties have reneged on their debt... perhaps other government entities might some day (California was closer than they would have liked)... But the US isn't obligated to pay back debts they didn't agree to.

[happyslug]

22. The Constitution FORBIDS the payment of Rebel Debts

See the Fourth Section of the 14th Amendment:
Amendment XIV (The First section of this Amendment stated that all person born in the US are full citizens and can not be denied any right except by due process of law. The Second Section repealed the 3/5 clause for slave, the Third Section debt with officers of the Confederacy who had been officers of the United States before the Civil War and finally the Fourth Section which made it illegal to pay debts incurred in rebellion against the United States):

Section 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any state shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

[BillZBubb]

4. For the most part, interest rates are set at auction.

When the US Treasury sells bonds, notes, and T-Bills, they are sold in an auction format. That sets the rate for those particular debt instruments and locks it in for the government until they expire. Any future borrowing has the rate determined the same way.

There are a few minor exceptions to this, but they can be ignored for this discussion.

Anyway, if we borrow $1 trillion today and the auction sets the rate at 5%, we pay 5% on that $1 trillion. If another $1 trillion is borrowed and the market sets the rate at 6%, we pay 6% only on the $1 trillion--it doesn't effect the prior borrowing.

[justa]

5. Just have to remember

When the time expires on the first $1 trillion, if the government hasn't saved enough to pay it off, then we have to borrow another $1 trillion at whatever the current rate might be at that time. As the debt increases, if investors lose faith, then the interest rates will have to climb to entice people to reinvest. The more we have to pay in interest the less we have for every thing else.

This is why I worry about not paying out old debt. It has become a vicious cycle. We borrow because we can not meet our needs and we can not meet our needs because we are paying so much interest on previous debt.

[mulethree]

24. Remember this too

If a company sells a bond at 10%, and later interest rates fall/credit rating improves, such that they can get a 7% rate; then they CALL in the old 10% bonds and pay them off before maturity and issue new 7% bonds instead.

Treasuries don't normally have a call option. So a 10% 30 year treasury is going to pay 10% for 30 years even if rates drop.

A few exceptions in the Carter years when treasuries were going for 12%+. They made them callable at 25 years and Clinton did call them in early.

[MrUnderhill]

7. Yes. Government borrowing is generally at a fixed rate.

With a few small exceptions... and understanding that we've shiften away from the 30-yr debt instruments to shorter-term ones... this is the general rule.

The rate of return on a newly purchased treasury security varies from day to day, but that's because the price changes constantly while the "face value" of the debt is unchanged. What the government pays on it is constant.

[papau]

13. The Gov's inflation protection bonds do have variable rates - but the

senario you are discussing - an auction - is as describe by DUer amBushed in post number 4 above and in DUer MrUnderhill's comments

[happyslug]

21. Yes and No.

It has been said before in this thread but the Government only issues bonds at a set rate of return. For example the Government will issue a $10,000 bond at 5% nominal interest. That bond is taken to the bond market and sold at auction. The bond rarely sells for exactly $10,000. It is either sold at a discount or a premium. A discount is when the stock sells for say $9,000 instead of $10,000. The nominal Rate will still be 5% but the Real rate, the rate on what the Government actually Received will be 9000/10,500 or 15%.

Now sometime a Bond is sold at a premium, that is the above $10,000 stock is sold for $10,250 which would make the REAL rate 2.5%.

[Inland]

23. Exception== Savings Bonds

Savings bonds rates change. But I don't think they are a huge factor.

[Rapier2]

25. notes

The US treasury is in essence the bank account for Uncle Sam. As you know when you get a check from him, like your tax return, it says US Treasury.

When they don't have enough money in the account to make the checks good they have to borrow the money. To do this the Fedreal Reserve conducts the auction of Treasury Bonds for them.

Auction means just what it says. They announce for instance that they will sell $15 billion of ten year duration bonds some day next week and the bidders make their bids on them. (buyers must bid thru the Feds Primary Dealers, the gang of 22, the mostly Wall Street firms which dominate world finance)

The vast majority of these bonds have a fixed interest rate, meaning the rate remains the same for the duration, in this case 10 years. In other words the vast majority of the US debt is fixed.

One thing however is that the total debt, which is the accumulation of every years deficit, grows and grows. This means that they have to continue to roll over their debt or in otherwords they have to borrow the money today to pay off the interest and principal on the bonds they sold 2,5,10,20 and even some 30 years ago.

In that way the interest rate is not fixed, permanently. There are still bonds from around 1980 out there paying nearly 15% interest. When those are paid off, partly with borrowed money of course, Uncle Sam can be happy that he only has to pay todays rates of around 4%.

Interest rates have been falling for 20 plus years since the early 80's. This has been great for Uncle Sam since his borrowing needs have been so gigantic. The interest on all those bonds, which comprises the entirity of the US Government debt, now near $8 trillion dollars, accounts for roughly 15% of all goverment spending annually. Those interest payments as a percentage all spending would obviously be much higher if interest rates were higher.

Let me stress this again. The US government debt is held in totally by those who bid on it's bonds.
(SS is the exception here. The SS 'Trust Fund' has a special interagency 'bond' or promise to repay with interest from the Treasury. They don't bid on these 'bonds' but just get the current rate. These SS 'bonds' or promises to repay now amount to around $3 trillion of the total $8 trillion debt. The entire 'crisis' in SS really amounts to the already cast in stone determination to welsh on those bonds. There is no question that we will repay the interest and principal on the nearing $1 1rillion in bonds owned by the Central Bank of China, but your dads and your debt is going to be liquidated)
It's amazing how so few people understand who owns Americas debt. It is pension funds,indviduals, banks and other financial institutions, corporations and foreign central banks.

Back to the interest rate Uncle Pays. While I said interest rates have been falling for 20 years, or to be more precise the trend in rates has been lower for that period the fact is that the trend to lower rates has probably come to an end. All trends reverse. The absolute low in long dated Treasury bonds, now the 10 year bond is the longest duration while in the past bonds as long as 30 years were sold, was set in May of 03. While it is of course possible that rates could fall back to those levels or lower any historic analysis of how markets trend (or so called markets I say because even the credit markets are corrupted to some degree) suggests that rates will trend up for some time to come. IF they rise strongly, combined with the again rapidly growing annual deficit, and thus total debt, it is possible that the interest cost vis a vis the entire budget could rise to 20% or 25% or even 30% of all spending. (another deep driver of the so called SS crisis, and the need to abondon that debt)

[Rapier2]

26. notes

How are interest rates set. In so far as US Treasury Bonds are concerned, and they are the benchmark, the foundation, the standard by which all interest rates are set or judged are set by those auctions. In other words they are set by the market. (Forget for now all the stuff about the Fed setting interst rates, which they do but only for the very shortest of maturity bonds, like 30 day)

Every time there is an auction, which nowdays is at least a couple of days every two weeks usually in amounts ranging up to $20 BILLION or more a day, buyers bid at what they of course are willing to take as an interest rate. Like you deciding not to buy a 2 years CD at 2% or put your money in a passbook savings account for 1.5% if they decide they need to get 4.25% on a ten year bond today they bid 4.25% (this isn't really how they bid, by rate. They bid by price. This becomes a slightly complex issue of how price is related to rates and I won't bother you with it. The important thing is the price they bid to pay for the bonds relates directly to the interest they agree to accept.

So rates are set by the market. Well, to a degree. There is a vast and complex set of things which determine why the 'market' meaning bidders, are willing to accept 4% on a ten year bond and many of those reasons have to do with the amount of money and credit flowing thru the national and world financial system. That in turn is determined in part by the Fed directly and indirectly. Also there is the issue of risk. In todays world risk has been relegated to the dustbin of history, led by Feds embrace of ever more arcane and complex credit instruments and methods of trading and accounting for them.

THere is a simple concept of real return. That is the stated rate of a bond minus inflation. Traditionally 3% was the standard expected real rate of return on Treasury Bonds. Today CPI inflation is stated to be in the 3% range, a number everyone KNOWS is low. The 10 year bond today is bid at 4.2%. So a real rate of return of less than 2%.

So why is that? There is no easy answer for that but know this. This ultra low, ahistoric, low real rate of return is quite simply the most important driver of the economy today. As we know there has been no growth in the number of jobs in 4 years. Only the depression years saw such a thing, no job number growth. Yet we are bombarded with rosy or at least postitive stories about "the economy" every day. "Profits are high" they tell us relentlessly. Why this disconnect. Because the ultra low real interest rate makes financial 'profit' easy. Shuffling paper for paper profits which flow in disproportionatly to the top 20% of the income earners and even more importatnly inflating the 'value' of financial assets such as stocks, which again of course ahe held mostly by the top.

All that is totally contingent upon easy and cheap credit. A vast ever growing flood of credit, and its obverse debt throughout the whole world but primarily driven by dollar denominated debt. Who needs jobs when GM can book billions in 'profits' on lending money at ultra low rates, as they lose money on ever car they sell. Come to think of it how can they make so much money lending at low rates?

Well that counter intuitive fact might take a library worth of books to attempt to explain and maybe Greenspan and the entire US led financial world is right to dismiss worries about the soundness of an economic system which gives not a hoot for stagnent and falling incomes for the majority of Americans or they fact that there are now new jobs, nor imagines there is any risk at all in the syatem but if they are wrong one day we may wake up and discover that the emperor had no clothes.

[atim]

27. The real question who the goverment is borrowing from? And why?

Wonder whether anyone seen the Money Master video
http://www.themoneymasters.com (i may be wrong)

What is money anyway? How it gets it value? what is fractional reserve? Why do we pay compound interest (usury) that is mathematically impossible to sustain?

For some answers
http://www.perfecteconomy.com/

We are enslaved only by our ignorance.


:)