Would You Lend to Tim Geithner On These Terms?

In an uncertain world, Treasury bonds are the one universal safe haven -- or so the economics texts say. They're where you park your money when you're afraid the world is ending (see 2008, October) or that a cradle of ancient civilization is about to unleash a global credit crisis (see last week, Greece). But in the long run, you have to look at a Treasury like any other investment, a tradeoff between risk and return. And these days, it's hard to see the return for all the risk.

No need to get to fancy about this. In the end, a Treasury is just a loan from you to Uncle Sam. The question you want to ask, as you would on any loan, is whether the rate you'll earn is worth the odds you won't get repaid. If you were a fixed income analyst, you might try to answer that question by analyzing the Federal Reserve's balance sheet or the balance of trade; but if you're not, you might just imagine that you're the lending officer at the Bank of You, interviewing Mr. and Mrs. Tim Geithner, who are applying to you for a loan. As I wrote in a post on The Fiscal Times, you might have a conversation like this:

Why do you need this loan? We provide our large family a vast array of services, from anti-terrorism to highway repair to unemployment relief, among many, many others. This year we plan to spend $3.8 trillion, of which we need to borrow $1.6 trillion.

How will you pay me back? Every year we collect a share of the income our kids produce, now about $14.2 trillion. Some of that will go to you.

Can I be sure? If we were ever to come up short of what we owed, we could just take more of our kids' money. And don't worry: We've always paid in full in the past.

Yes, but have you ever borrowed this much before? Well, no. This loan comes to about 10.6% of our total family income, more than at any point in the past 60 years. Oh, and we expect to borrow nearly as much each year for the next 10.

And hasn't the recession hurt your ability to pay? Well, yes. It lowered our kids income, so we'll need either to take a larger share of their earnings or collect less income.

Can you foresee any big expenses in the future that could hurt your ability to pay? Our parents are getting older and will increasingly rely on us for pension and medical costs. That could wipe us out.

But since you can see that coming, you have a plan for how to pay for it, don't you? Actually, uh, no.

Why don't you just spend less? At the moment, our family doesn't have the will power.

What's your plan B? We keep a guy in the basement, Ben Bernanke, who prints very convincing $100 bills

Wow, you're kind of a risky bet. What interest rate are you willing to pay? Glad you asked. How does 0.8% on a two-year loan sound?

To be realistic, there's zero chance that the U.S. might simply walk away from its debt, like an underwater homeowner (or like Russia in 1998). But that's not the only way to reneg. The Federal Reserve could simply create enough money out of thin air to buy up newly minted Treasury bonds. (See the Geithner family's Plan B above.) If that happened, inflation would explode. You'd get back the dollars you were promised as a Treasury investor, but each dollar would be worth just a fraction of its original value.

Now, markets aren't dumb. There's still enough fear of sudden crisis and long-term deflation that world's investors continue to buy as many bonds as the Treasury can issue. (Although, the Chinese have been selling lately, which could be ominous.) And you should always have some Treasuries in your portfolio as a hedge against just those risks. I do.

But these are the facts: President Obama has submitted a budget that calls for the country to borrow more in the next three years of its life than it did in the first 200. There is no apparent will to rein in spending and no plan at all to deal with the inevitable explosion of Social Security and Medicare costs when the baby boom generation retires. Maybe it's just me. But to lend under those circumstances, I'd want to be paid a lot more than 0.8%.