The U.S. Treasury Has Run Out Of Money!

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by: Alan Longbon
Summary

The US treasury is limited by a law that sets a ceiling on the amount of US treasury bonds [UST] it is allowed to issue to match government spending.

The spending limit known as the 'debt ceiling'  has been reached.

The Fed [FOMC] is now alone in providing both system liquidity and managing the target interest rate, known as the Federal Funds Rate [FFR].

April is the seasonal low for system liquidity.

A perfect storm of voluntary budget constraints, low seasonal liquidity, trade deals and the tabling of the Mueller report are combining to create investment opportunities.

The purpose of this article is to describe and set out the ramifications of a system liquidity squeeze caused by the US treasury reaching its legal bond selling limit, a low time in seasonal system liquidity and Global Trumpism.

The FOMC and UST work together to manage system liquidity, that is the amount of money available in the US financial system. Too much money in the system and the FFR falls below the target level. Too little money in the system and the FFR rises above the target rate, and a liquidity crisis in the finance market could occur whereby one or more banks in the system cannot meet their reserve requirements at the end of the days trading.

The table below, taken from last Friday's daily treasury statement, shows that the UST has reached the limit of its authorized bond selling amount.

(Source: US Treasury)

The UST cannot legally sell any more funds with which to provide funds to the US government's spending balance until the spending limit 'debt ceiling' is raised by an act of Congress.

Under current institutional arrangements, governments around the world voluntarily issue debt into the private bond markets to match $-for-$ their net spending flows in each period. A sovereign government within a fiat currency system does not have to issue any debt and could run continuous fiscal deficits (that is, forever) with a zero public debt.

(Source: Professor William Mitchell)

The Total Public Debt subject to limit is now equal to the Statutory Debt Limit.

The Fed is now alone in the role of liquidity provider and FFR maintainer and cannot rely on the UST to offset bank reserve drains and adds in the normal way. One half of the dynamic duo is artificially offline due to a legally imposed voluntary budget constraint.

The chart below shows the seasonal Treasury Cash Balance [TCB] over a number of years plus an average for the last five years.

US treasury cash balance [You can see how this above information is used in this Blog post from Mr. Robert P. Balan.]

What makes this even worse is that tax time is coming, and at this time about half a trillion dollars' worth of liquidity will be drained out of the system when taxes are paid. This can be seen from the Treasury summary chart below from the same time last year.

Treasury statement to Jan 2019

We are now about to plunge into trading day 80 [April] where seasonal liquidity is lowest. This means less money around to buy assets of all kinds, falling bond yields, falling equities, and a falling dollar.

The unusual situation where the UST has been put out of action by a legal technicality could not have come at a worse time seasonally speaking because this is the time when liquidity is lowest and the system the most exposed and fragile.

A stock market plunge and panic now will be much deeper than it might otherwise have been because there is much less liquidity in the system to buy up the falling assets, so they fall further.

A key member of the Plunge Protection Team [PPT], which really does exist, see this article, is the Secretary of the Treasury. His hands are currently tied by the federal government voluntary budget constraint.

The perfect storm forms

One can see how a perfect storm is forming off the financial coast:

1. UST is taken out of action by the voluntary budget constraint [debt ceiling].

2. Tax time is here, and system liquidity is at one of its lowest seasonal points.

3. The Trump Trade talks are a flop; more tariffs are the result rather than less. [tariffs are a tax and result in still less system liquidity, income, and profits]

4. The Mueller Report is tabled and exposes all sorts of irregularities in the Trump election campaign. Not a financial event but will have a big market sentiment impact.

5. The current market downturn becomes a stock market panic and exceeds the December 2018 plunge.

6. President Trump uses the debt ceiling process to again shut down the government to get funding for a Mexico wall and so prolongs and complicates the low seasonal liquidity levels and falling markets.

What is an investor to do?

The most likely course of events is:

1. Continued downward stock market movement into April that may well turn into a market panic and go much lower than low hydraulic system liquidity [lack of money] would normally call for. Sit out the carnage in cash or go to US Bonds (TLT). I would not recommend shorting a secular bull market no matter how tempting that might appear.

2. The debt ceiling is raised by Congress, and the UST is again able to participate as a member of the PPT and also resume its normal role of funding federal government operations by matching deficit spending with bond sales and assisting the Fed to maintain system liquidity and the FFR target rate.

3. The UST and Fed work together to provide system liquidity and assets are bid back up, and bond yields rise again after April. Time to buy SPY, QQQ and DIA.

4. The trade talks blow over, and business adjusts to higher tariffs and a higher level of overall taxation via tariffs. All the while markets rise.

5. The Mueller report process runs its course and like Bill Clinton and the Starr Report moves quietly into the background. All the while markets rise.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.