Thanks to the readers for all the e-mails so far. Most have concentrated on the problem of foreign ownership of U.S. debt, and the potential impact on the dollar should foreigners stop funding our profligate spending.
First, let's make a distinction between debt monetization and what the Fed is currently doing with their Treasury buying program. A classic debt monetization is a solution to overwhelming domestic debt. Its printing money to actually pay off the debt because the government has no other solutions. If you want to claim that the Treasury might someday get to this point, have at it. But its clear that in the here and now, the Fed's buying program isn't meant to solve the problem of deficit spending. The Fed wants to buy Treasury bonds in an attempt to put more money into the U.S. economy in the name of fighting deflation. It might also be an attempt to force interest rates lower, although I'm increasingly doubtful that is their intention. Either way, Treasuries are just serving as the helicopter out of which the Fed is throwing money. In other words, Treasuries are a means to an end. In a monetization, buying Treasuries is an end of itself.That being said, its legitimate for foreign investors to fear the possibility of a monetization. I can't say its out of the realm of possibility, and if your China, it would be such a disaster, they have to be watching it.
Right now, I think the U.S. and China are living in a state of mutually assured destruction. China has too much invested in U.S. dollars, and thus can't afford to have it tank. Meanwhile the U.S. has borrowed too much from China. We can't afford to have the Chinese exit.
Therefore thinking about Chinese exit is a bit like thinking about a nuclear attack during the cold war. Can't deny the possibility, but it wouldn't be in anyone's interest to allow it to happen.
How worried are foreign investors? So far they are mostly just talking. Here is the bid/cover ratio on recent 2yr, 5yr, and 10yr auctions. If the Treasury is auctioning $20 billion and the bid/cover is 2, that means they they got $40 billion in total bids.
No obvious pattern here. Plenty of buyers for Treasuries. For me, I don't take much from any given bid/cover, because a bid at any price counts. I.e., if you bid 4% for the new 10-year, that counts as a bid, even if that's actually 40bps away from where the 10-year is. But as long as the bid/cover is solidly above 1, we aren't in danger of a failed auction.
Another worthwhile auction stat to watch is indirect bidders, where foreign central banks normally hide out.
No real pattern here either.
TIC data measures foreign buying directly, but its always a little dated. Anyway, here is net purchases (buys minus sales) of Treasuries. The red line is a 12-month rolling average.
Again, no obvious pattern of selling. Now if you want to see what foreign panic looks like, check out the chart on Agencies.
The Jutland Wastes are not to traveled lightly! I've heard the Russians blew out all their Agency positions entirely, but I've also heard Chinese insurers say they'd be a natural buyer of GSE debt if it were indeed full faith and credit. Part of this too reflects an overall decline in Agency issuance, but let there be no doubt, foreigners panicked after FN/FRE conservatorship.
The overall TIC does show some pattern of decline...
But it appears to reflect a change in risk tolerance. Since overall TIC is declining while Treasury purchases are about flat, it means that foreign portfolios are more heavily Treasury weighted than in the past.
I've said before that the dollar won't have the same dominance as a reserve currency in 25 years. But I be surprised if the impact is felt in any given year. The big foreign bond buyers have come face to face with a dollar disaster. Just because it didn't happen doesn't mean it won't result in changes. But they will be long-term changes. The kind that are hard to trade on.
To those who really fear a China sell-off, my challenge is to show me hard evidence that its happening.
18 comments:
The issue here is STAGFLATION, business stagnation accompanied by inflation. Even a lower transactions velocity figure will not stop rates from rising:
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Purge it, strip it, or keep it. It's probably too long winded. But the issue here is STAGFLATION, business stagnation accompanied by inflation. Even a lower transactions velocity figure will not stop rates from rising:
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It would seem that somewhere, somehow, if total net debt (not just Federal Debt) keeps rising faster than production (Real-GDP), the burden of interest charges at some point now indefinite and unknown, but nevertheless real, will become too great to carry.
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Any deficit, by definition, creates a demand for loan-funds. The larger the deficit, the higher interest rates will be, or the less they will fall.
Any given deficit should be evaluated in terms of: (1) the size of the deficit in the context of the size of future deficits, and the accumulated debt relative to the means and costs of financing the whole: (2) how the deficit is financed: (a) from savings or (b) commercial bank credit, i.e., newly created money; and (3) the purpose for which the deficits are incurred.
Prorating the federal deficits over the entire spectrum of federal expenditures, it can be said that virtually all of the current deficits are attributable to defense spending, military and civil service pensions, interest on the debt, and welfare and unemployment benefits. Social security for now is not include in the above list since only a very small proportion of social security benefits are financed from non-social security taxes. From an economic standpoint, only interest is “untouchable”.
If current projections of Federal Deficits materialize in this, and the next few years, interest rates (both long and short-term) will be driven up sharply by the increased demand for loan funds. I.e., any recovery in the economy will present a “Catch 22” situation. An upturn in the economy will add increased private demand for loan funds to the insatiable demands of the Federal Government. The consequent rise in interest rates will effectively abort any recovery.
Raising taxes to accomplish a reduction in the deficit would be counter-productive. Most of this debt is short-term. Combine this with the factor with the constant roll-over of some of the long-term debt and it becomes obvious that the burden of higher interest rates will be compounded. The burden becomes a function of the major portion of the debt, not just the current deficits. The burden, in fact, becomes exponential. In other words, if the trend is not stopped, the debt inevitably has to be repudiated.
Those who are wont to minimize the ill effects of the deficit are prone to compare the size of the deficit with nominal GDP, as if the volume of nominal GDP were independent of the size of the deficit. Unprecedentedly large deficits “absorb” a disproportionately large share of nominal GDP
Present deficits are unprecedented no matter how measured, and the past gives us no reliable guide to the future effects of deficit financing, beneficial or otherwise.
To appraise the effect of the federal budget deficit on interest rates, it is necessary to compare the deficit, not to GDP, but to the volume of current savings made available to the credit markets. The current deficit is absorbing about 24% (2007)of gross savings.
The more alarming aspect of the deficits is not the effect on interest rates but the effect of high interest rates on the level of taxable income and the volume of taxes required to serve a cumulative debt now exceeding $11+ trillion. Both high interest rates and high taxes induce stagflation, thus eroding the tax base and increasing the volume of futures deficits.
It should be recalled that the charges on debt are related to a cumulative figure; and since the multiplier effects of debt expansion on income, the ingredient from which the charges must inevitably be paid, is a non-cumulative figure, it would seem that the time will inevitably arrive when further debt expansion is no longer a practical or possible expedient, either to provide full employment or to keep debt charges with tolerable limits.
The significant economic purposes for which a debt was contracted, or the manner in which it was financed, is of inestimatable value in evaluating it's impact.
For example if the debt was acquired to finance the acquisition of a (1) (new-security), the proceeds of which are used to finance plant and equipment expansion, or the construction of a new house, rather than the purchase of an (2) (existing-security) to finance the purchase of an existing house (read bailout), or to finance (1) (inventory-expansion), rather than refinance (2) (existing-inventories).
The former types of investment are designated as "real" as contrasted to the latter, which constitute "financial" investment (existing homes). Financial investment provides a relatively insignificant demand for labor and materials and in some instances the over-all effects may actually be retarding to the economy. Compared to real investment,it is rather inconsequential as a contributor to employment and production. Only debt growing out of real investment or consumption makes an actual direct demand for labor and materials.
The Social Security Trust Fund is not a fund; money is not deposited in the fund, nor are drafts drawn against it. The “Fund” consists of records kept by the U.S. Treasury, which reflect the net differences in Social Security receipts and expenditures, plus accrued interest on the accumulated balance. Although the “baby boomers” begin to come “on stream” around the year 2010, deficits in the Fund will not occur until a few years later. Subsequent deficits in the SSTF are expected to largely consume the Fund since the Fund is not a fund, how will the baby boomers get bank their contributions, plus accrued tax-free interest? The answer: by higher non-Social Security taxes and/or borrowing.
Social Security is a “transfer” not an “accumulation” system. The capacity of the Social Security System or any other agency of the U.S. government, to meet its obligations is, and will remain, dependent on the taxing and borrowing capacity of the U.S. Government.
There will come a time ( unpredictable ) when it will be impossible for the government ( federal ) to collect enough in taxes to pay all of its expenses, including interest on the national debt. The Gov't can of course borrow an indefinite amount through the Fed. ( concealed greenbacking ) given a few changes in existing law.
But that would lead to hyper inflation - i.e., a collapse in the credit of the Gov't. So the easy way, is the way the French did it in 1960. Simply say that beginning Jan 1 ( or any other date ), new dollars will be issued, and that each new dollar is worth 100 old dollars. Then follow that up with a largely state controlled economy.
In 1960, the French economist / mathmetician Jacques Rueff, during Charles de Gaulle's presidency, converted the old franc, to a nouveau franc, equal to 100 of the old franc. However, even with this substitution, inflation continued to erode the currency's value, though at lower rates of change, in comparison to other countries. And this new franc equaled 20 cents to a U.S. dollar. The old rate was 5.00 to a dollar.
In 1960, the French franc, which was one of the weakest currencies, overnight, became one of the strongest. Correcting policies included plans to 1) balance the budget, 2) stablize the currency, and 3) eliminate currency controls.
The gold content of the franc increased 100%, & 1) foreign exchange rates, and 2) France was on a managed paper standard; externally, on a modified gold bullion standard. With the new policies, France's economy strengthened, and the franc became fully convertible @ approximately its gold par, into gold for foreign exchange and into foreign currencies.
With the introduction of the euro, the franc in Jan. 1, 1999, was worth less than 1/8 of its Jan. 1, 1960 value
Care to run some of the same charts broken down by duration?
As Brad Setser is fond of pointing out, foreign demand for U.S. Treasuries have never been higher. But as he goes on to mention, that demand has become heavily concentrated in the short end of the curve. This is consistent with foreign central banks becoming worried that we plan to "print" our way out of our debts.
That said, I agree with you that there are vast deflationary forces at work. And so while I do believe the "dollar is toast" thesis, my gut says that it is way too early.
Can you explain how the Fed's process differs from Japan style sterilization?
Maybe I'm missing something here but I think the Feds are diverging from the BOJ's historical path.
I think that it is fitting that treasury sec Geithner is in China this week as GM collapses because China is running what equates to the largest captive trade financing in the world with the US. America buys their stuff and they finance the US's deficit in order to keep the American economy going so that the US continues to buy their goods.
While Geithner is in Beijing he ought to point to GM to tell the Chinese what happens when the captive financier (read GMAC) can no longer make the loans. Namely the producer goes belly up.
Much has been made about how much the US needs China to finance the deficit and certainly this much is true. But take a look at what happened over the last few quarters and it is painfully obvious that the Chinese domestic demand picture is lacking the ability to fuel the growth that Chinese officials want to see and therefore they need the US consumer as well.
I think Geithner may also want to take a stop in the Middle East at some point soon as there is another trade finance game which needs to be reminded.
Indeed I think Geither has a much easier "sale" to make than most people think as he goes to the international reserves managers who hold US government debt and take in revenue from trade with the US.
Here's the reason why inflation wins in the end: It's widely accepted that the reason Japan never really "got through" their lost decade is that they are a society of savers. No action by the government ended up being able to change that. The U.S. is the polar opposite. We are a nation of spenders and borrowers. No event or government action will change that either. Therefore, we will keep spending in the long term. Therefore we (as a country and as citizens) will just fall further and further in debt, and instead of slowing spending, we will just print more money to service the debt and that will be the eventual cause of runaway inflation. No one will feel poorer along the way because we will continue to get raises every year, tax breaks, and whatever else it takes us to keep spending. But that can't go on forever without grave implications...
id: If I recall correctly, something like half (about 2.5trn) of treasury securities are due in 2 years or less. Looking at the size and frequency of bill and 2y note auctions compared to 10y, that's not surprising.
But this doesn't account for the IOUs to the Social Security trust fund, or any of the future unfunded liabilities; obviously, these are much longer term. However, the value of these will increase due to higher rates/inflation in the future. This makes me think that treasuries will suffer disproportionately if/when we have a period of higher rates/inflation.
ID:
My auction charts show different duration bonds. That's the only hard data I know of on what foreigners might be buying. Lots of anecdotes agree with your view.
Mike:
I think you make a good point about Americans being fundamental spenders. I think that's why we are getting the "green shoots" that we are getting. I just don't know that it will be enough.
Here is a very good article from David Altig (SVP at Atlanta FRB) over at Macroblog about monetization.
http://macroblog.typepad.com/macroblog/2009/06/debt-and-money.html
Where'd you get the indirect bid data?
Bloomberg.
Oh my god, there's a lot of useful information in this post!
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