Earlier this year, there was a series of articles by fellow SA author Alan Longbon, which explained that, because the debt ceiling prevented the Treasury from issuing new Treasury securities into the market, the banks were forced into stiffer competition in the secondary bond market and the gold market in order to meet regulatory compliance in their tier 1 asset reserves. (you can read the relevant articles here: 1, 2, 3, 4 ). The purpose of this piece is to explain why, although the debt ceiling has been removed and a $2 trillion bipartisan spending agreement has been signed, the rallies in bonds and gold have not ended.
Why the actions of the Treasury matter
It boils down to an accounting identity: the Federal government's budget balance, minus the current account balance (net exports), equals the private sector balance.
GDP = Federal Spending [G] + Non-Federal spending [P] + Net Exports [X]
As a percentage of GDP, all three sectors sum to zero and balance each other out.
This means that if, for simplicity's sake, we assume that exports net to zero, then we see that:
Federal Deficits = Non-Federal surplus
Federal spending must be accounted for by matching Treasury securities. This means that when there is a government shutdown or when a self-imposed debt limit is reached - both of which occurred in the first half of the year - the Treasury is prevented from selling new Treasury securities.
In such situations, the Treasury must take extraordinary measures in order to find the dollars it needs to pay the bills. These measures involve moving money between internal Government accounts, not unlike a family that suffers a job loss and has to take money from retirement accounts in order to afford the groceries.
This Treasury drought had a knock-on effect for banks (in addition to other consequences) that involved the bond and gold markets. In order to lend and conduct business, banks must maintain reserves in the form of tier 1 assets: Treasury bonds or gold.
Without a supply of new Treasuries, the banks bid up the bonds in the secondary market and increased their gold buying in order to maintain their store of tier 1 assets. This caused yields to drop and gold to rally.
In late July, the Government agreed to eliminate the arbitrary debt limit and agreed on a bipartisan spending plan which the president signed into law.
Now that the Treasury drought was over, it was assumed that the bond and gold rallies would end... but they haven't.
What has the Treasury been doing since the ceiling was lifted?
Just like a family that has spent some time without a source of income must replace the funds that were taken from its pension fund once a job is found, so to must the Government "make whole" the accounts it used to pay the bills.
This is what it has been doing since the beginning of August. However, it is not, at least for now, selling huge amounts of new Treasuries to the public. It is creating huge amounts of Treasuries within Government accounts which do not show up as public debt, and therefore, the Treasury drought continues.
Below are the two most recent statements from the Daily Treasury Statement. Notice in Table lllA, that the only debt transactions listed (yellow highlight) are for the "Government Account Series", and that there is no activity in the "regular series".
Despite the $2.9 trillion of activity (green underline in August 12 table), it was all outside of the public marketplace, as evidenced by the fact that the "Total Public Debt" actually decreased on August 9 and only rose by ~$6 billion on August 12. That is proof that the Treasury drought is not yet over, and explains why the bond and gold rallies aren't either; new treasury sales have not started.
(Source: US Treasury)
(Source: US Treasury)
We have been trying, with little success, to learn whether the Treasury has to wait for Congress to return to work before it can start to spend and sell new Treasuries to the public. Perhaps we could use our readers to crowdsource the answer to that question.
What we do know, however, is that the Treasury drought is not yet over, and neither are the bond and gold rallies.
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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.