James Pethokoukis

Politics and policy from inside Washington

Can the US keep financing its debt?

October 30, 2009

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.

Comments

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?

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