James Pethokoukis

Politics and policy from inside Washington

Can the US keep financing its debt?

Oct 30, 2009 14:42 UTC

The great Andy Busch of BMO Capital Markets sees some problems down the road:

It’s called carry, but not like currency carry. As most know, banks can fund themselves at 0.1%-0.25% as the Federal Reserve keeps Fed Funds at 0.0%-0.25%. Then banks are incentivized to find the safest, highest return they can with this cash.

Then where is this cheap money going? Why back to the US Treasury! Banks earn a somewhat risk free return on their cheap money from the Fed by purchasing US Treasury securities.

But there’s one more big incentive for banks to do this carry trade. If they buy something other than Treasury securities, they have to set aside a percentage of the assets value based on the risk weighted asset rating. This carry is only limited by what regulators will allow the bank’s leverage ratios to reach.

As the world looks to see how the massive US Treasury auctions are going, don’t be fooled into thinking that the US government can easily fund itself because the markets have confidence in defect reduction down the road. As the economy recovers and the business environment shifts, this bank-Treasury carry trade incentive will be reduced as the Fed raises interest rates and the cost of funding the carry goes up.

Therefore, the appetite for US government securities will be reduced as well and we’ll get a much better view of how the world feels about the US massive fiscal deficit.

COMMENT

This is a subject that has been intriguing me. Thanks for the concise little article summarizing the problem. My question is this. What about the Chinese, Japanese etc monies that are still flowing into all US bonds? For now anyway, it seems that issuing short term debt at under 1% is a fantastic deal for the US taxpayer, since we are continuing to fund our operations at insanely low levels. Even the 10. 20 and 30 year bonds are low.

If I were the Chinese, I’d be concerned about what happens to the value of my US bonds when interest rates finally go up. What will happen to the world economy when the Fed starts to raise rates? Won’t this cause a crises for some governments because they will be forced to hold all their US bonds to maturity or “mark” them to “market” then face huge losses if they try to sell old Low interest bonds in favor of buying newer higher interest rate bonds?

Are we experiencing a US Bond Bubble?

Aren’t we driving the Asian economies to create their own central bank system so that they will no longer be dependent on US bonds for stability?

When that happens, 10 or 20 years from now when they not only control all manufacturing due to low wage workers, but also control their own destiny with their own stable bond system. Where does that leave the US?

Posted by Michael Woods | Report as abusive

Barney Frank: Let’s pack the Fed with doves

Oct 30, 2009 14:26 UTC

Here is Barney Frank at yesterday’s House Financial Services hearing:

I had a study done. Ninety percent of Federal Open Market Committee [dissents] are from regional bank presidents and 90 percent of the 90 percent are for higher interest rates.

Those are inappropriately placed private businessmen, or women, occasionally, picked by other private businessmen, and occasionally women, and they should not be setting public policy.

I don’t care that the Fed rejected what the Treasury said. That may be a nice discussion among gentlemen. The Fed will not reject it when we, I promise you, next year, take up legislatively the issue. And I think it’s very clear. You should not have private citizens like the presidents of the regional banks voting on policy. And I guarantee that will happen.

Me: Along with the Fed audit bill, it is clear Congress wants to have more influence over the Fed. This, right at the time when global financial markets will have to remain confident America will not inflate its way out of its debt.

COMMENT

The current fiat U.S. Dollar is not constitutional. I don’t know what U.S. Constitution most people read, but mine says that only gold and silver are legal tender. The history of the Continental Dollar was the reason for this little inclusion to the document.

IMO the markets should be shorting the fiat U.S. Dollar and U.S. Treasuries to punish the current crop of prodigal politicians in the D.C. swamp.

Posted by Austrian School | Report as abusive

Economic fears drive Pelosi’s healthcare push

Oct 30, 2009 14:17 UTC

First you have to realize that Mark Zandi has become the de facto chief economist for congressional Democrats. Here is a bit from his testimony yesterday to the Joint Economic Committee:

The Great Recession is over, but the recovery will be a difficult slog through much of next year. The risks are also uncomfortably high that the economy will backtrack into recession. This would be an especially dark scenario, as the economy would almost certainly be engulfed in a deflationary cycle of falling wages and prices. The Federal Reserve and fiscal policymakers would also have fewer options and resources with which to respond.
A range of problems suggest that such a scenario cannot be easily dismissed. Most obvious are the very high and rising unemployment and increasingly weak wage growth, the mounting foreclosure crisis, rising commercial mortgage loan defaults and resulting small bank failures, budget problems at state and local governments, and dysfunctional structured-finance markets that are restricting credit to consumers and businesses.

Me: So if you are Speaker Pelosi and Harry Reid, here is how you interpret this: The economy will still stink on Election Day 2012. Voter disapproval of Dems will continue rise.  Better pass healthcare as soon as possible or you won’t be able to pass it all.

COMMENT

Good point. Another problem is that the benefits to any bill that passes won’t start until 2013, but the taxes will start earlier, which won’t go over well, especially in a bad economy. Obama told people their premiums would fall if he passed his bill, but this seems unlikely to happen. That is when we’ll hear that you just can’t trust the insurance industry and it’s time for single-payer.

  •