"Three Bites - Interest Rates, Exports and Hillary Clinton"

Sydney M. Williams

Thought of the Day

“Three Bites - Interest Rates, Exports and Hillary Clinton”

September 10, 2010

Very low interest rates have provided a unique opportunity for borrowers, or, as Thursday’s New York Times put it in a front page headline, “Debtors Feast at the Expense of the Frugal”. Jim Grant writes of the phenomena in his recent Grant’s Interest Rate Observer when he speaks of IBM “bookending” the great bull market in bonds, begun in 1981 and still underway, though appearing to me to be getting long in the tooth. The bonds that IBM issued in 1981 paid 850 basis points more than the three year, one percent notes IBM issued a couple of weeks ago. One could also point out the thirteen hundred basis point decline in Ten-Year Treasuries during the same thirty years.

Yields on Investment Grade Corporate Bonds have declined from 6.35% at the end of 2008 to 4.48% today, while yields on their High Yield cousins have fallen from 17.43% to 8.58% in the same time. The Wall Street Journal pointed out yesterday that $51 billion in corporate bonds and leveraged loans came to the market in the past two days. Earlier this week, for example, the health care company Allergan raised $650 million in ten year bonds for a cost of 3.375%! At the same time, according to Bloomberg, 68 of the S&P 500 companies have dividend yields that exceed that of their debt.

Low rates, while good news for borrowers, serve to mask excess leverage, as interest costs are kept exceptionally low. However, when things seem too good to be true they often are. And the enormous deficits and obligations being rung up by the federal and state governments will almost certainly extend into a period of rising rates, putting added pressure on already bloated budgets. Of course, if deflation is to be our future, today’s interest costs may turn out to be expensive, but, in my opinion, that is a low probability bet.

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On Thursday morning, in a somewhat rare piece of good economic news, the trade deficit narrowed from $50 billion in June to $42.8 billion in July, thanks to a 1.8% increase in exports and a 2.1% drop in imports. Exports represent only 12% of our economy (and, of course, imports are subtracted from GDP), but if consumers continue to retrench (which they should for the sake of their balance sheets) we will have to rely increasingly on exports to generate the kind of growth the economy needs to shrug off the malaise of the present. For that to happen, however, our leaders in Washington must focus on permitting American businesses to be more globally competitive - to worry less about perceived acts of unfairness on the part of trading partners and competitors and more on lowering barriers and reducing taxes. Unfortunately a recent survey by the World Economic Forum of the world’s most competitive economies indicated that the United States, in terms of competitive advantage, slipped to fourth place from second, behind Switzerland, Singapore and Sweden. Two or three years ago, the U.S. had been number one.

Any success in meaningfully expanding world trade is going to have to overcome the objections of our shrinking industrial-based unions, not an easy task for a President who relies heavily on financial support from them. It will also require the quick adoption of free trade agreements from Colombia, Panama and South Korea now awaiting the President’s signature. Nevertheless, Thursday’s news was welcome.

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In a remarkable response to a questioner on the federal deficit following a major speech at the Council on Foreign Relations early this week, Secretary of State Hillary Clinton answered: “It poses a national security threat in two ways: it undermines our capacity to act in our own interest and it does constrain us when constraint may be undesirable.” Later she added that the deficit projects a “message of weakness.” Interestingly, Reuters reported the comment as did a number of TV news shows, but neither the New York Times nor the Wall Street Journal mentioned it in their articles on her speech.

Perhaps I am reading too much into her comments, but, at a time when the deficit is at record highs, the President’s poll numbers are low and when his economic proposals show no let up in government spending, her answers raise questions as to her future plans. A legacy of President Clinton, and one for which he should feel justifiably proud, is that he left the White House with a fiscal surplus. The federal deficit is now roughly three times the level it was when President Bush, no paragon when it came to deficits, left office. And, of course, should interest rates begin to rise the costs of the debt will mount. In an op-ed in this morning’s Wall Street Journal, Jason DeSena Trennert of Strategas Research Partners, that 60% of America’s sovereign debt is set to mature within three years and that the weighted average cost of the U.S.’s debt is 1.21%. A 200 basis point increase on the $8.3 trillion in debt would add $160 billion to the annual budget.

Secretary of State Clinton is not known for her casual, off-the-cuff comments. She is a deliberate, controlled person, who had to have understood the consequences of her answers. One cannot help wonder if she has plans for mounting a challenge to Mr. Obama in 2012.