Today’s post is written by Michael Green, Senior Commercial Loan Originator with Counsel Mortgage Group, LLC.  Mike writes monthly on the commercial mortgage market.  Check back each month for his commentary.  

Unless you live in a cave, you’re aware of gold’s incredible run in the wake of the declining dollar (USD), and recently, the inevitable “correction” … down about 11%.  The catalyst:  the nomination of Kevin Warsh to serve as the next chair of the Fed.  Without getting into the weeds reviewing Warsh’s qualifications & philosophy of interest rate management, his previous criticisms of current Fed chief Powell imply his willingness, if not desire, to lower interest rates, and sooner than has been the case. While lower interest rates would reduce the Government’s current debt expense, today over $1 trillion/year, it would more comfortably allow for additional government borrowing, pushing US debt even higher than the $37 trillion+ of today.  It’s important to note that the Fed’s reduction of the fed funds rate only provides the downstream benefit to public borrowing in the short end, only out to 2-3 years.

A new report from the Committee for a Responsible Federal Budget warned that high public borrowing levels could spark a sharp economic downturn. Such a crisis, the report said, could begin when investors lose confidence in America’s fiscal outlook, leading them to demand sharply higher interest rates — especially on 10-year Treasury notes, which influence CRE borrowing costs.  This series of events would continue the devaluation of the USD, which according to President Trump is a good thing – it reduces our interest expenses and also makes our exports cheaper to the importing country.  Rising long term yields would reduce the value of existing debt and could trigger domino-effect failures at financial institutions as higher interest expenses deepen the debt spiral. 

A financial crisis could begin if (when?) investors lose confidence in America’s fiscal outlook and view U.S. debt as increasingly risky. In that case, they would demand higher interest rates – especially on long-term securities including the 10-yr Treasury note which heavily influences CRE mortgage rates. As yields climb, the value of existing debt declines, potentially shaking banks and triggering failures at financial institutions. Then-rising interest costs would, in turn, fuel the debt spiral even further. 

An inflation crisis, by contrast, could erupt if government borrowing leads the Fed to print additional money to finance spending. This would occur if Treasury auctions become under-subscribed and the Fed steps in to (continue) buying newly issued Treasuries.  New-to-be Fed chair Warsh has stated his intent to reduce the Fed’s balance sheet, making this less likely to occur.  However, at the time rather than have a failed auction, the Fed would undoubtedly participate.  A failed auction might occur if bond market vigilantes demand a higher rate for the new Treasuries than the Treasury is willing to give.  The Fed might attempt yield curve control or even tolerate higher inflation to shrink the real value of debt. But those measures would likely push investors to demand even higher rates in the future, worsening the long-term fiscal position.

An austerity crisis, while not likely, could emerge if Washington tries to reduce deficit spending too rapidly – even balance the budget !  (Remember, it’s an election year !)  Forced fiscal tightening – reducing or eliminating selected government handouts – could drive the economy into a deep recession, with surging unemployment, falling incomes, and weaker consumer demand, feeding the very downturn it sought to prevent. 

Lastly, and most likely, a gradual weakening (crisis is too inflammatory a term) may unfold over years, marked by a slow erosion of living standards and weakening economic conditions – an extended slide rather than a shock. But wait … looking around and over your shoulder you’ll recognize that this has already been happening for years.  But the arithmetic is being pushed to the peak.  I see on the US Debt Clock (https://www.usdebtclock.org/) our current debt stands at $38.7 trillion.  Perhaps more importantly, our debt-to-GDP ratio is 121%.  The race is for our GDP to increase fast enough to keep the ratio from increasing. 

How is the race going? … so far, so good. 

But turning to you, how are you weathering the storm?  Are you ploughing ahead with your umbrella into the increasing wind when you should be looking for the lifeboat?  

At Counsel Mortgage, we have the oars, the life jackets, and yes, even the lifeboat.