We had this as risk no.2 here. It is simple really. If supply of newly issued Treasuries is bigger than the demand for them, real interest rates will go up. And that’s definitely a risk..
Who Will Buy Our Debt?
By: Barry Elias
For the financial cognoscenti, the cause of our fiscal and monetary crisis is very clear: deflection of responsibility.
We face $57 trillion in public and private debt; $40 trillion in future, unfunded Social Security and Medicare liabilities; and projected federal government deficits on the order of $1 trillion to $2 trillion annually. Is America seriously looking to deflect this responsibility yet again?
Maybe we can hire “smarter” financial engineers from “more qualified educational institutions” to produce the template that will move us through the 21st century and beyond.
A funny thing happened on the way to bank: It turns out the folks financing our operations are looking for people to borrow from, too.
How can this be?
The International monetary Fund (IMF) reports that credit growth in the United States and Europe have turned negative, from $2.24 trillion and $127.3 billion, respectively, just two years ago. Global projections for 2009 are not optimistic: GDP, negative 1.3 percent; trade, negative 11 percent; capital flow, negative 6.18 percent; current account imbalance-to-GDP, 4 percent; and public debt-to-GDP, 75 percent (and 110 percent in 2014).
These projections are operative despite the massive expansion of monetary reserves and central bank assets in the United States, United Kingdom, and Europe. In the past two years, central bank assets doubled and monetary reserves as a percent of GDP skyrocketed eight times over.
It seems the old Keynesian model may not be an accurate reflection of how government expenditure policy impacts the total economy, when you incorporate rational expectations. Dr. John B. Taylor, senior fellow in economics at Stanford University, predicts a six fold decrease in economic velocity compared with that estimated by the administration.
The basis for this analysis involves “crowding out” of innovative, creative, and efficient private investment by the public sector. Moreover, there is an expectation by the private sector that this intervention is temporary and produces an uncertain environment, which deters future commitments of capital, labor, and raw materials (i.e., business investment).
A February 2009 report to the Secretary of the Treasury by the treasury borrowing advisory committee of the Securities Industry and Financial Markets Association, suggests the United States will require $3 trillion to $4 trillion in debt issues for 2009 and 2010. Is there world demand for this type of product?
Purchases of U.S. Treasuries plummeted 60 percent last year to $412 billion from the previous three year annual average of $1 trillion.
The BRIC nations (Brazil, Russia, India, and China), despite a decrease in reserves, have been purchasing U.S. Treasuries at the expense of U.S. agency securities. This asset allocation substitution does not bode well for future financing of our debt.
China is auspiciously positioned going forward; it has a relatively robust balance sheet, showing surpluses in foreign assets, currency reserves, and trade balances. Its public debt-to-GDP, discounted for purchasing power parity (PPP) is about 8.5 percent vs. 65 percent for the United States. Per capita PPP debt is 60 times greater in the United States. Moreover, China grew at 9 percent last year and has a positive outlook for growth this year as well.
Last year China purchased $1.05 trillion in U.S. securities. The Council on Foreign Relations reports the Chinese have understated their foreign assets by $700 billion from September 2007 through September 2008, indicating a current total of $2.3 trillion (50 percent of GDP).
In addition, from mid-2006 to mid-2007, China purchased U.S. securities through third parties, including the United Kingdom and Hong Kong. The Chinese purchases represented 59 percent of U.K. Treasury purchases and 92 percent of agency purchases by the U.K. and Hong Kong combined. From mid-2007 onward, the figures are 12 percent and 56 percent, respectively.
China clearly has the potential to assist in financing U.S. debt obligations. This economic construct may have considerable geopolitical implications going forward.
In addition to China, major purchasers of US securities in 2008 were the Cayman Islands, Bermuda, and Japan with $8.71 trillion, $1.38 trillion, and $ 1.31 trillion, respectively.
Harvard economists N. Gregory Mankiw and Kenneth Rogoff recommend the central bank produce inflation to help pay the debt we are accumulating. This seems like another abdication of responsibility to monetize the debt (i.e., create new dollars electronically, or through physical printing, to pay for new debt issues).
This functions as a convenient political elixir for those elected to the legislative and executive branches; it simply deflects fiscal policy decision-making onto opaque, nebulous monetary intervention.
Pay attention to H.R. 1207, the Federal Transparency Act of 2009. This piece of legislation resides in the financial services subcommittee of the U.S. House of Representatives and would require an official audit of the Federal Reserve Bank.
Currently, the Fed excludes itself from this practice by exercising legal options. It would be advantageous to the country if the Inspector General can offer a definitive accounting of the $2 trillion on-budget entries, as well as the $9 trillion off-budget ones.
As the debt is monetized and inflated “away,” the onerous impact will, regressively and disproportionately, affect those most in need. This is anathema to the purported underlying philosophy of the administration.