Posts Tagged ‘u.s. debt’

U.S. Treasury Sweating Bullets Over Financing Swelling Deficits

July 30th, 2009 Comments off
A Treasury auction earlier in the week for two-year debt drew a lacklustre response, setting the stage for what followed a couple of days later, when an auction for five-year debt was conducted. To say that the results were below expectation would be a severe understatement. To convey the importance of what occurred , take the words of William O’Donnell, who heads  U.S. Treasury strategy at RBS Securities in Greenwich Connecticut: “It was just a horrendous result, it was the weakest bid-to-cover since September 2008, and by my numbers it was the biggest tail since February 1993. It was just a very, very weak result.”
The auction sold $39 billion in 5-year debt at yields far above what had been anticipated, in the process sinking the value of Treasury bonds. This occurrence is a harbinger of the growing fiscal dangers that are now a full component of the ongoing Global Economic Crisis.

The warning is crystal clear. Before the onset of the current financial and economic crisis, the U.S. had structural deficits measured in the hundreds of billions of dollars. Now, however, the fiscally toxic combination of Wall Street bailouts and economic stimulus programs requiring massive public borrowing have created the unprecedented phenomenon of multi-trillion dollar deficits, equal to 15% or more of the entire United States GDP. If would be bad enough if only the U.S. was engaged in such staggeringly high levels of public borrowing. However, virtually every major economy on the globe, including China and Japan, America’s two largest creditors, are also engaging in large deficit-financed stimulus programs. At a time when the U.S. requirement for credit is ballooning, its traditional sources of such largesse are under fiscal pressures of their own. Only by elevating yields on its Treasury bills will the United States be able to attract interest in its ever-expanding menu of Treasury auctions.

Raising yields on Treasuries will greatly increase the cost of public borrowing, thus adding to the fiscal imbalance confronting Washington. The growing unease regarding the size of the U.S. deficit by both sovereign wealth funds and private investors, and the real possibility that Washington will lose its coveted AAA status, has implications beyond Treasury yields. Policy decisions that address the nation’s fiscal imbalance may become essential in order to maintain interest in purchasing U.S. public debt instruments. This would mean budget cuts and tax increases, which would greatly increase the likelihood of a double-dip recession.

Given the track record of the U.S. political establishment, I suspect that they will delay a serious  deliberation on the fast-developing fiscal crisis confronting the public finances of the federal budget until it is too late to avoid the most critical consequences. What the recent Treasury auction demonstrated is that Washington may be fast approaching a situation where  insufficient demand exists to satisfy the government’s appetite for borrowed money. What happens then? The most likely result would be monetization of the debt by the Federal Reserve. In effect, the Fed would conjure money out of thin air, and use this newly printed stack of greenbacks to purchase Treasuries that are left behind by global investors and sovereign wealth funds. Should that unhappy day arrive, you can lay the U.S. dollar to rest, for it will not be worth the paper it is printed on.



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U.S. Economy Risks Hellish Prospect of Hyperinflation

May 24th, 2009 Comments off
The global financial and economic crisis arose out of radical deflation in the U.S. housing market, as the real estate asset bubble split asunder. With the collapse in housing prices came the contraction of another asset bubble; equities. The ongoing demand destruction has also deflated commodity prices from their recent peaks, giving rise to a collective view among economic policymakers that deflation represents the single greatest risk to the global economy.
In itself, deflation is a dangerous economic phenomenon. Historians of the Great Depression often refer to deflation in the 1930s as a contributing factor to the prolongation of that epochal downturn in the world’s economy. Looking closely at the dynamics of deflation, it is not difficult to see why this is a dangerous economic state to be in. When prices of major durable goods, especially homes, continue to decline, this inserts a strong dose of uncertainty into the human decision-making process. Not many consumers are likely to take out a mortgage on a home that they believe will actually decline in value right after the legal papers are signed. Or so the classical economic theory goes.
However, though not downgrading the danger of deflation, I believe policymakers are ignoring other factors regarding this economic and financial condition. Furthermore, the U.S. government and Federal Reserve in particular, are taking steps to “cure” deflation that will inevitably lead to hyperinflation, which in the long-term may prove far more destructive to the long-term health of the U.S. economy.
History demonstrates that deflation is not a permanent condition. Market forces, unencumbered by fiscal and monetary intervention, eventually restore pricing equilibrium. At a certain point prices of major durables such as homes are low enough to encourage new categories of consumers to enter the marketplace. As demand is restored, prices stabilize and then resume their upward ascent. It is all a question of time. However, key decision-makers in the United States are not paragons of patience. They want deflation cured immediately, which explains why the U.S. Treasury and Federal Reserve are hell-bent on policies that are guaranteed to be inflationary. The question is how bad will inflation ultimately be.
Massive quantitative easing by the Fed is pouring trillions of fiat U.S. dollars into the money supply, essentially conjured out of thin air. This is being done without transparency, the rationale being that frozen credit markets require a vast expansion of the money supply in an attempt to get the arteries of commerce flowing again. Similarly, the U.S. government is spending vast amounts of money it does not have, with the Treasury Department selling unprecedented levels of government debt in a frantic effort to fund the wildly expanding U.S. deficit. These two forces, quantitative easing and multi-trillion dollar deficits, are the core ingredients of an explosive fiscal cocktail that I believe will ultimately lead to hyperinflation.
What exactly is hyperinflation? Economists disagree on a common definition, so I will offer one myself. Double-digit inflation extending over a period of at least two years would arguably be a hyperinflationary period. It can get much worse, witness Weimar Germany in the early 1920’s and Zimbabwe at present. The most recent experience the United States had with this unstable economic condition was in 1981, when the annual CPI rate exceeded 13%. The cure was draconian; Federal Reserve Chairman Paul Volcker engineered a severe economic recession that created the highest level of U.S. unemployment since the Great Depression-until now. The federal funds rate, currently near zero, rose to above 20% under Volcker’s harsh discipline. Eventually high inflation was purged out of the system and economic growth was restored, however the monetary regimen was punitive for several years.

The current monetary and fiscal policies being enacted by the key economic decision-makers in the United States are laying the groundwork for a far more dangerous inflationary environment than anything encountered by Paul Volcker. The explosive growth in the money supply and government debt is simply unsustainable without severe inflation. It must be kept in mind that the Federal government is not the only public authority engaged in massive deficit spending. Throughout America, state, county and municipal governments are faced with imploding tax revenues and lack the ability or political flexibility to cut services to a level commensurate with revenue flows. Both the Fed and the public sector are engaging in a reckless gamble; borrow like crazy in the hope that this overdose of economic stimulation will restore growth to the economy and normal tax revenues, leading to a decreased and sustainable level of public sector indebtedness.

If one believes that the policymakers running the Federal Reserve, Treasury and Federal government, the same architects of the Global Economic Crisis, are smart enough to now get everything right, perhaps we may escape the worst consequences of their turbo-charged fiscal and monetary policies. However, there are growing indications that global investors and the broader market are beginning to reach a far more sobering assessment.

In an interview with Bloomberg News, Bill Gross, co-chief investment officer of PIMCO (Pacific Investment Management Company) suggested that the coveted AAA credit rating U.S. government debt now benefits from will eventually be downgraded. “The markets are beginning to anticipate the possibility of a downgrade,” Gross said.

China, the major purchaser of Treasuries and holder of $1 trillion of U.S. government debt, is already on record as expressing concern for the integrity of its American investments, and has begun actively exploring alternatives to the U.S. dollar as the primary global reserve currency. These moves by China are not based on fears of expropriation of its U.S. assets, but focuses on the specter of hyperinflation destroying much of the value of assets denominated in U.S. dollars. No doubt China’s economic experts are well aware of the growing number of economists who are convinced that the U.S. will be unable to service its rapidly expanding debt burden without significant inflation. Inflation in monetary terms means the erosion of the intrinsic value of the American dollar.

What is most frightening about the policy moves being enacted by the Fed and Treasury is that their actions may not be a reckless gamble after all. They may have come to the conclusion that only hyperinflation will enable the United Sates to avoid national insolvency. In effect, they may be pursuing the exact opposite course undertaken by Paul Volcker in the early 1980’s. If that is their prescription for the dire economic crisis confronting the U.S., then one must conclude that Ben Bernanke, Timothy Geithner and Larry Summers have learned nothing from history Once the spigot of hyperinflation is tuned on, it becomes a cascading torrent that is almost impossible to switch off, and which in its wake inflicts inconceivable levels of economic, political and social devastation. Before it is too late, President Obama should put the brakes on his economic team’s dangerous gamble with the haunting specter of hyperinflation. If he fails to act in time, a hellish prospect may be his economic and political legacy.


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