Is It Really Debt If You Never Plan To Pay It Back?

  
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To investors,

The United States has approximately $25 trillion in debt. The country was expected to experience a $1 trillion deficit this year, which is the difference between how much money they spend and how much money they earn.

But then coronavirus hit. And as the great Mike Tyson once said, everyone has a plan until they get punched in the mouth.

The health crisis required an unprecedented government response that led to a near complete shut down of the global economy. This put many businesses and individuals in a tough spot. They had their source of income shut down or materially hindered. More than 30 million Americans lost their jobs. And numerous industries saw their revenue vanish.

In an effort to mitigate the economic carnage, the Federal Reserve and US government began announcing monetary stimulus packages aimed at putting money in the hands of those who needed it. People will debate whether the programs were structured perfectly or not, but no one can deny that the Fed was quick to act and was much more aggressive than many predicted.

The packages saw increases in unemployment benefits, forgivable loans to small businesses, and bailouts of major industries. This all costs a lot of money for the federal government to fund. So they are obviously just funding everything with the revenue that they get from our taxes and other income sources, right?

Wrong. At the same time that spending had to drastically increase to address coronavirus issues, revenue for local, state, and federal governments was drastically decreasing as well. Remember, everyone has been sitting at home for almost two months now, so naturally each income source has drastically decreased.

Whether you’re a business, a family, or the government, it is never a good situation when you have to spend way more than you make. This violates one of the core principals of finance. And this was after the US government was already expecting to run a $1 trillion deficit for the year without coronavirus happening.

So how does the government fund so much spending if they don’t already have the money? They do what any business or individual would do — they borrow what they need. And yesterday we were told that the US Treasury is planning to borrow $2.99 TRILLION dollars in the 90 day period between April and June. To put that in perspective, the US government has $25 trillion in total debt so this would be more than a 10% increase in just 90 days.

Now obviously the Treasury is run by a bunch of smart people who spend time thinking about this every day. They aren’t perfect, but they also aren’t complete idiots. Why would they borrow so much money right now? Easy — the cost of borrowing money is so low that they are actually financially incentivized to do it.

The way this works is through Treasury bonds. They issue an IOU to investors saying “give me X dollars and I will pay you back in a certain amount of time at the Treasury bond rate.” These bonds can mature at various times from 3 months to 30 years and the interest rates are all sub 1% except for the longest timeline bond.

So when the US government needs money, they issue bonds to raise capital. Those bonds represent debt. But here is the big question — is it really debt if you never plan to pay it back?

Now I don’t mean that the US government is planning to not make people whole on the Treasury bonds. That is possible, but it is a very, very small probability in my opinion. I’m more specifically talking about the idea that the US government continues to increase the national debt and doesn’t have a plan to (a) run a budget surplus, nor (b) eventually pay off all the debt.

What they are really running is a mirage of confidence. As long as investors continue to believe that the US government will find a way to pay back their Treasury bonds, those investors will continue to lend money to the government. The funds to pay back individuals can come from revenue-generating activities (ex: taxes) or from the proceeds of issuing more debt (ex: essentially re-financing the original bonds).

If the confidence is ever lost though, there would be a massive problem. The United States would owe almost $30 trillion to investors and no one would believe they are going to be paid back. It would lead to one of the largest defaults in history. Again, I don’t think we are close to that scenario yet, but I do believe that the Treasury is playing a game that has become impossible to win.

The federal government will never be able to pay their debt. They can’t drive enough revenue to get to profitability and issuing more debt to raise capital would only make the situation worse. Investors are constantly betting billions of dollars in the markets on what they believe will be the second and third order effects of this situation, so I won’t opine on what I believe. I don’t have true skin in the game here, which makes my opinion frankly obsolete.

Now one saving grace for the government at the moment is that those Treasury bond rates are so low. This makes the debt service easier. The debt service is essentially how much money you owe to the lenders at any given time. Here is an example.

If the government borrows $100 at a 2% rate, they would owe $2. But if they borrow $100 at a 1% rate, they would only owe $1. The trick when rates are low is to borrow $200 at 1% so you owe the same $2 from the first example, but you got twice the money from investors. This is essentially what the government is doing now.

If they had issued $3 trillion of 5 year Treasury bonds at 2% interest rates, they would owe $60 billion in interest. If they issue that same $3 trillion at the current 0.36% 5 year rate, they will owe $10.8 billion. Another way to think of this is if the government only wanted to pay $10.8 billion in interest, they are now getting 5.5x more money in exchange for that interest.

Cheap money makes the world go ‘round. The US Treasury is borrowing an incredible amount of money, which is going to drive the federal deficit for 2020 to over $3.5 trillion by the new estimates. It may have a lower cost of capital, but I don’t think it is really fair to call this debt.

They may have intentions to pay back the individual investors who buy the bonds, but they have no intention (or plan!) to pay off all this debt. To make it even worse, the debt continues to get bigger and bigger. Hopefully they can continue to play this financial engineering game, because a default of the United States would be catastrophic to the global economy.

Hope this helps each of you understand what is happening right now. I know these situations can be complex, so I’m doing my best to break them down into simple language. Remember, the financial system is dependent on at least half of the population not understanding how money works unfortunately.

Have a great day and we’ll talk tomorrow!

-Pomp


This installment of The Pomp Letter is free for everyone. I send this email to our investors daily. If you would also like to receive it every morning, join the 45,000 other investors today.


THE RUNDOWN:

Crypto Exchanges Boost Hiring in Wake of Coronavirus Crash: A slew of crypto exchanges are embarking on hiring sprees while job losses are soaring. Kraken LLC said on Monday that it had been planning to hire 250 staffers this year, but will instead recruit 350. Binance Holdings Ltd., which has more than 1,000 employees, expanded its workforce by 25% in the first quarter and is beefing up its team supporting Binance Pool, a new mining operation launched in April. Exchange OkEx, also with a workforce of more than 1,000, said it will announce a global hiring initiative in May. Coinbase Inc. lists dozens of openings. Read more.

IBM, Mastercard Join Digital Identity Project Building ‘Ecosystems of Trust:’ The highly specialized world of digital identity is opening itself to a wider audience. Announced Tuesday, the Trust over IP Foundation is backed by governments, nonprofits and private-sector firms. Key players include Mastercard, IBM and the Canadian Province of British Columbia. A vast ecosystem of public bodies and private companies, large and small, are working on establishing decentralized digital trust, using an array of technologies. The ToIP Foundation, which will live within the Linux Foundation, is a move to rein together core issues that matter to all of them, as well as creating appropriate technologies. Read more.

Mysterious Company Files New Lawsuit Over Ripple’s $1.1B XRP Sale: A little-known Puerto Rico-based company has gone after Ripple in court, accusing the blockchain firm of running an unregistered securities sale of the XRP cryptocurrency. The company, Bitcoin Manipulation Abatement, filed a lawsuit Friday in San Francisco, alleging both Ripple and its CEO, Brad Garlinghouse, had violated federal and Californian laws on seven counts when hosting its $1.1 billion XRP sale. Read more.

US Senate Staffers Float Blockchain Voting if Chamber Goes Remote: U.S. Senate staffers on the Permanent Subcommittee on Investigations, hunting for tech to keep the chamber legislating through crises, floated blockchain voting in an April 30 "continuity of Senate" memo. Coming several days before the Senate’s planned return from its COVID-19 recess, the 29-page memo, which is not a proposal to change Senate rules or from the committee that reviews them, preceded the subcommittee’s Thursday roundtable on crisis-time continuity solutions. Read more.

Peter Thiel-Backed Digital Bank N26 Raises Another $100 Million, Bracing for Coronavirus Uncertainty: German digital bank N26 has raised an additional $100 million in funding, as it braces for economic uncertainty from the coronavirus pandemic. The investment, backed by existing investors such as Chinese tech giant Tencent and Peter Thiel’s Valar Ventures, is an extension to the company’s Series D investment round announced early last year. It brings the total raised in that round to $570 million, while the company has now raised $770 million to date. Read more.


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Nathan Latka is a serial entrepreneur with a top business podcast, an investor in B2B SaaS companies, and a bestselling author. He is incredibly thoughtful and has spend a lot of time building various products, so Nathan is able to share highly tactical advice on various topics. Hope you enjoy this one!

In this conversation, Nathan and I discuss:

  • The future of media

  • How he tactically grew his podcast to 10 million downloads

  • Why he believes debt financing for SaaS businesses is the next frontier

  • How business in a post-COVID world will evolve

I really enjoyed this conversation with Nathan. Hopefully you enjoy it too.

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