The debt reckoning has arrived: Total debt owed now approaches $60 trillion while Fed wrestles with interest rate confidence game.

Some people may be oblivious to the recent historical interest rate moves being experienced in the bond markets.  Many on Wall Street probably assumed that the Fed had an unlimited ability to pull the wool over the eyes of the American public.  Yet the reaction with interest rates concludes an interesting chapter in American central banking policy.  The Fed can no longer preach for a lower interest rate.  After the brutal reaction, the Fed has softened its rhetoric on the “taper” of quantitative easing even though there is really no evidence showing the Fed is tapering anything at all.  The quick reversal in interest rates signifies a strong reaction by the market.  It is fascinating to see how much outside money is now flowing back into the US to purchase stocks, real estate, and other real tangible goods.  In other words, global investors are now demanding payment for all that cheap credit lent out.  The era of cheap debt is now reversing and the piper is demanding to be paid.

Total debt owed

The total US debt markets are now over 3 times our annual GDP:

We have largely become a nation built on debt.  There were a few recent headlines championing the growth in household sector debt ex-mortgage debt but the reporting failed to acknowledge that the bulk of debt growth has come at the hands of student loan debt.  And why would this be a problem?  The problem arises from the record level of student debt delinquencies:

In other words, one of the most problematic debt sectors is seeing the largest growth at a time when many are unable to pay it back.  Yet somehow, this passes as a good sign for the recovery.  Even though the $1 trillion in student debt is enormous, it is merely one part of the bigger debt market that now approaches close to $60 trillion.  The interest rate move is significant in the bond markets because a bond is merely a promise to pay a loan back with a fixed rate of interest and all initial principal.

What we are seeing however, is a reversal of cheap debt coming back to flood the markets at the expenses of a dwindling middle class.

Fed confidence game

The Fed is walking a fine line when it comes to the psychological confidence game.  After the massive reaction in the bond markets the Fed quickly softened its stance:

“(CSMonitor) Federal Reserve Board Chairman Bernanke spoke at an economic conference near Boston Wednesday, saying the Fed will continue to pour stimulus into the US economy — at least until unemployment and inflation improve.”

This is an incredibly quick change of heart here and the statement provides a vast window in which the Fed can act.  While the Fed talks about easing QE and other programs, the evidence shows nothing to this effect:

The Fed’s balance sheet which remains unaudited in any significant way shows no sign of tapering or slowing down.  We are quickly on our way to seeing the Fed’s balance sheet hit $4 trillion.  The Fed is essentially serving as the one giant bad bank but is also the key player (only player) in the mortgage markets.  Without the unprecedented intervention in the housing market, real interest rates would be around 6 to 7 percent for a typical mortgage.  We have no way of finding out the real rate since an artificial market has been created.

The chart above shows a very clear pattern.  The Fed since the crisis hit in 2007 has expanded its balance sheet from roughly $800 billion of liquid items to $3.5 trillion of questionable securities and artificially low mortgages (via QE and the MBS program).

Yet as many of you are well aware, the US is increasingly borrowing money from the world.  The world realizes that the Fed is merely bluffing so guess what?  Money is now flowing back into US markets to purchase stocks, real estate, and other goods pushing up prices while the middle class is literally living paycheck to paycheck.  This is one of the reasons how it is possible to have a booming real estate market, a record in the stock market, while the middle class shrinks, and 47 million Americans are on food stamps.  To sum it up, global investors are calling the Fed’s bluff and are now diving into the US market to buy it up on the cheap with a growing erosion of US dollars.

Interest rates react

The markets once realizing the Fed was reaching a reckoning when it comes to debt, decided to react as you would imagine:

The above move pushes the 10-year Treasury rate to its highest level since 2011.  Keep in mind the debt markets and Fed balance sheet have continued to grow since that time.  While this is a blow to domestic financial institutions leveraging the daylights out of low rates, it will also hit consumers who are on a razor’s edge when it comes to their finances.  In reality, the stock market gains from many large companies are not trickling down to Americans because many of the large companies are adding jobs outside of the US:

There is simply too much debt floating in the market and the Fed is backed into a corner.  Global investors realize this and are choosing to drive dollars back into the US by buying up real estate, stocks, and other tangible investments.  So you have inflation coming from outside forces while the middle class essentially has watched the Fed assist banks and Wall Street in parceling off pieces of the domestic economy to global buyers.  The underlying key to remember is this is happening at the expense of the middle class given that the top echelon of our society has benefitted mightily from this arrangement.  The reckoning is here and there is a limit to how much debt you can have while not adding any value domestically.

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