This week, the Treasury is auctioning 101B worth of 2, 5, and 7 year notes. They sold 40B 2 year notes Monday at a yield of .00949%. Yesterday they sold a record 35B 5 year notes and today they will offer 26B of 7 year notes. Next week they continue with an estimated 73B of 3,10 and 30 year bonds. The total amount borrowed during the quarter ending March 31st was 481B. During the current quarter ending June 30th, it is estimated they will borrow 515B dollars.
Thus it can be implied from the massive current quarter’s needs that tax receipts have shrunk dramatically because of the recession. If total borrowing as estimated by some is at three trillion that means the 4th quarter borrowing by the Treasury will be huge.
Where will all this money come from? Evans-Pritchard in the London Telegraph writes,
We cannot take it for granted that the global bond markets will prove deep enough to fund the $6 trillion or so needed for the Obama fiscal package, US-European bank bailouts, and ballooning deficits almost everywhere.
Countries that cannot print money like the US are at the biggest risk of default or bankruptcy. That means that countries that borrowed abroad, like in Eastern Europe, are at the biggest risk of default. The U.S. hedge fund Hayman Advisers is betting on the biggest wave of state bankruptcies and restructuring since 1934. Most of the worst cases are in Europe. “We spent a good part of six months combing through the world’s sovereign balance sheets to understand how much leverage we are dealing with” Hayman’s Kyle Bass told Evans-Pritchard, and “the results are shocking.”
These comments would imply that, to the degree the world’s supply of investment capital is fungible, the aggressive issuance of US Treasuries will hurt the world’s weaker economies. Austrian Swiss and German banks with East European loans are at risk. As the level of borrowing activity by the Treasury during the next five months increases, this may benefit the USD at the expense of the Euro and the Swiss franc.
What will happen, though, in the US? Won’t these massive borrowings disrupt our capital markets?. Normally when there is a massive demand for something, the price goes up. So far that has not been the case, as the rate of interest has only climbed modestly with 10 year notes yielding a little less than 3% and the 30 year bond a little under 4%. ( The results of the 5 year auction are just coming out and the yields are higher than forecast. Is this is the beginning of a trend??)
Personally, I think lending money for 30 years at under 4% when the Fed is printing money like crazy seems really stupid. As Jim Rogers says, he is looking for a place to short the long bond, and that is probably not a bad trade. The 30 year bonds had a high yield of 15.2% in 1981 shortly after the great Jimmy Carter left office.
So far the Fed has been active trying to keep rates down. When they buy bonds in the open market, as they have been doing, they help to keep the rates low. Private owners of bonds sell them to the Federal Reserve, and the Fed prints and issues new money to pay for those bonds. This increases the Fed’s balance sheet and gives the sellers of the bonds new money to buy more bonds.
Though the Fed is supposed to be independent of the Treasury, it looks like Geithner and Bernanke have some kind of monetary daisy chain going and this is no longer the case. The total size of the Fed’s balance sheet has increased over 1 trillion dollars this year. There has been a dramatic increase in the money supply, and this normally causes inflation.
As the supply of Treasuries increases going forward, it is imperative we closely monitor a number of factors. Do the rates increase a little or a lot? What does the yield curve do? Will the public, fearing deferred inflation, be more aggressive buying Treasury Inflation Protected Securities (TIPS)? How much demand are we seeing from overseas buyers?
In a sense the Treasury, by its issuance of debt, is draining the global capital pool. To the extent this money is raised in an orderly manner, well received both domestically and in the world, these auctions are probably supportive of the dollar. If new money flows in, they of course need to buy dollars.
Can something go wrong? Of course: rates may go up and choke out private sector borrowers, thereby hurting the economic recovery. Investors may lose confidence in the US leaders, or their policies, and reduce their dollar holdings.
We live in a world of quick and constant change. The biggest risks to this plan are unintended consequences and unforeseen political and economic changes. We are unable to see very far down the path so it is best to stay alert.
Disclosure: No positions
