the Federal Government is signing up for. In an effort to keep the US
economy from plunging the Keynesian response was to ramp up the deficit
and spend Federal dollars. It is clearly working. It looks likely that
the next six months will show positive GDP growth. It is possible that
one or more of these quarters could be above the 3% trend line we need
to put a dent in unemployment. The question is can this recovery be
sustained?
To
a significant extent, the sustainability of the recovery will be
dependant on the Fed’s ability to keep interest rates at historically
low levels. That will be a very tall order. The Fed is facing the
strongest laws of economics: supply and demand. At some point that
basic law will exert itself. The only question is when.
There
can be little confidence in the forecasts of future deficits. A few
short years ago the prevailing estimates for deficits was in the $400b
range. Then 08 happened and an extra $1 trillion of borrowing was
required to plug the hole. The current estimates for the deficit is $1
trillion for each of the next nine years. Assume for the sake of
discussion that were to prove correct.
Total debt outstanding is
$12t. Of this, $2.5t is held by the Social Security Trust fund, the
public holds the balance of $9.5t. The Trust Fund will not be
significantly increasing its holdings of Treasury IOUs over the next
five-years, they will be net sellers by 2014. This means that 100% of
the new money requirement will have to be sold to public investors.
The
following chart looks at Treasury debt issuance for the nine months
from October 08 through June of 09. During that period Treasury raised
New Money totaling $1.4t. But in order to do that they had to issue a
total of $6.7t in new securities. The difference of $5.3t was rolling
over of securities that matured during the period. The majority of this
refinancing activity was maturing Treasury bills with short-term
maturities. However a significant (and growing) amount is longer term
securities.

Some
time ago Treasury produced estimates of the average life of the
country’s debt. The following shows that they are projecting an average
life of public debt of 55 months for the next few years. It is unlikely
that they will achieve these goals, but lets give them the benefit of
doubt and call the average life of 60 months, or five years.

The
five-year average life implies that one half of the debt will mature
during that period. Straight arithmetic suggests that $6 trillion will
need to be refinanced over the next five years. Round that down and
call it $1 trillion per year. On average, the old money roll over and
the new money requirement total an average of $2 trillion per year, for
the foreseeable future.
Quantitative easing is not a solution
to this problem. The Fed will monetize at least $1.75 trillion before
it is done with its POMO purchases. There can be no doubt that the Fed
purchases allowed Treasury to sell the vast amount of paper that it
did. Without the Fed’s constant intervention we would have already had
a failed auction.
The inflation adjusted return on Treasury
paper with a maturity less than two-years is currently -1%. For
ten-year maturities the return is at best 1.5% pretax. For foreign
holders who also face a risk of a decline in the dollar, the returns
are negative for the entire thirty-year investment horizon.
If
the Fed responds to this by extending and expanding its QE purchases of
existing public sector debt (either Treasuries or Agency MBS) the
dollar will fall like a stone. No one in the global financial community
likes this program any longer. If it is allowed to continue there will
be a very swift market reaction. There is a lot of dumb money around,
but there is not $2 trillion of dumb money to support this.
Bernanke
has said that he will end the QE policy. He has also said that he will
maintain the current zero interest rate monetary policy for, “the
foreseeable future”. If you believe what he is saying then you have to
assume that failed Treasury auctions will be in our future. When a
ten-year bid to cover ratio falls to 1.05 the Black Swan will swim up
the Hudson and attack Wall Street once again.
The most likely
outcome is that Bernanke will try to finesse this problem. He will
maintain zero interest rates until the market forces him to react. At
that point a rapid increase in the Fed Funds rate will be required.
This has happened before. Greenspan did the same thing before he left
the helm at the Fed. He engineered 17 increases in the Funds rate over
a 24-month period. The following chart shows that ramp up. Those
increases ended the cheap money from ARMs. That led to a correction in
housing demand. A small portion of the mortgage market, Sub Prime, took
a predictable hit. But then the unpredictable happened and we had the
economic collapse of 2008. It probably would have happened at some time
in the future, the excesses were there. However, the 08 mess was
directly correlated to these rapid rate increases:

Mr.
Bernanke is a scholar of the Depression. That knowledge has served us
well the past eighteen-months. It is time for Mr. Bernanke to look at a
different historical period. He needs to review how successfully the
Fed withdrew monetary stimulus in 2006. If he fails to focus on this
period of history it is likely that the results will be the same. The
soft landing of sustained low interest rates and multi-trillion dollar
funding requirements would appear to be the least probable outcome of
them all.
Look for talk along these lines in Pittsburgh this week.


Bruce, interesting move by Fannie today, starting to squeeze out the MI companies???
https://www.efanniemae.com/sf/guides/ssg/annltrs/pdf/2009/0929.pdf
Good article and I agree, to a point.
Bruce leaves out the oil price component - that drove interest rates from 1% to 5.5% beginning in 2003. He also leaves out the current dollar/crude trade that measures dollar worth (or lack of same) in the physical world. Oil price is the governor on dollar fluctuation.
In the abstract world of finance and fiat money, the Fed can theoretically monetize - put in Bernanke's closet - all the world's accumulated debt and monetize the service costs as well. This would reformulate the US's sovereign obligations as a gigantic 'Option Arm' mortgage with a recast term of ... never! None of this money- creation would have any effect on the dollar because none of the funds would ever see circulation, just like the current increase in the Fed balance sheet and increase in base money are invisible. The effects of the transactions on institutional balance sheets would be made manifest the form of reserves ... which would also be lodged in Bernanke's closet.
The way things are going, it would take little in the way of suspension of disbelief to get to the point where the Fed monetizes ... everything and nobody would care!
"Gold is the corpse of value." Neal Stephenson, Cryptonomicon
A dollar on a balance sheet is worth a [nominal] dollar. A dollar on the Income Statement is worth $15.
If one owns gold as collateral prudently to buy profitable equities, one may survive the coming economic difficulties.
"Those increases ended the cheap money from ARMs."
Cheap money was the problem, not the solution. A fast ramp would not have been needed if the rate was never taken so low to begin with. The fast ramp was acknowledgment that the damage was already done.
"then the unpredictable happened" newbie, eh?
Bruce -
Once again I stand in admiration of your knowledge. You make me regret going to college. Nicely done! I think sites like this will challenge universities in terms of not only knowledge, but also real world situations in real time.
Anyways...The law of unintended consequences ends up dictating what happens in the future. If I were to judge the future by comments made by the Federal Reserve I would be broke. Other than the "Greenspan Put" the Fed has been the worst indicator of future perfomance.
I've tried to find what the Fed said (or did) during the great depression, but to this day I can't find a shred of evidence.
The Fed has a HORRIBLE track record in not only addressing financial problems but also in fueling existing problems.
I wouldn't say abolish the FED, but I am definately not taking their advice for my portfolio(s)
"If it is allowed to continue there will be a very swift market reaction. There is a lot of dumb money around, but there is not $2 trillion of dumb money to support this."
Mish's BS blog should recruit a lot more suckers.
If the US government goes bankrupt, what happens
to the USD, all stock and all bond prices, and
the level of business transactions in the US
economy?
Buy gold and get the hell out.
Gold's a fool's play. If the USD collapses, gold will become too expensive for most people to use for trade, because there will be no circulation of the medium. Realistically, any new currency that emerges will be based upon energy production capability, as the dollar was until 1973. Without energy, you're reduced to cottage industry, manual planting of crops and horses as the primary mechanism for distribution. Without gold, you don't have any gold.
no gold is a moron's play....
gold and silver will emerge as currency again
should the frn truly collapse....in fact
gold sustains the value of the dollar contrary
to the twisted arguments to deny it....that's
why the gold exchanges were introduced in this
country in 1975 because the stupid decision
of nixon remove the backing of the dollar...
silver provides granularity where gold is too
coarse....
an energy based money is absolutely and totally
retarded and our dollar has never ever has been
energy based...
you display the most deplorable and puerile
understanding of money i have encountered.....
you totally confuse utility of assets with
utility of assets as money....you advocate
what is little more than a barter system...
i am not trying to personally insult you but
energy (or its production) is utterly
preposterous as money and the logic used to
defend it is utter lysenkoism....
without gold you have no wealth
how can you buy a cup of coffee with a gold bar ?
he who owns the gold makes the rules.
If the Federal Government goes bankrupt, what happens to the USD, all stock and all bond prices, and US currency?
the usd is a debt, income, and confiscation based
currency....repudiation of debt eliminates
dollars or dollar value depending upon how it
is handled....bond prices fall fall fall
as does the currency....
but we have examples in the past on how to
approach such problems such as alexander
hamilton did....
ellen brown has suggested that the treasury
buy back all debt as opposed to the federal
reserve doing so.....
Depends upon the nature of the bankruptcy, and the participants involved. We have singularity level events all around us - the possibility of hyperinflation, the possibility of a long-drawn out heat death, the potential for commodity wars. In physics, singularity events typically don't indicate that you're coming to the end of the universe, but that you are undergoing a phase transition where the rules are different from what you knew before. This is the situation we're running into economically right now - we have too great an imbalance in real wealth distribution given the population size and cultural expectations. We've never had 6.5 billion people on the planet given these conditions, combined with a dynamic, 24/7 electronic market that is able to both respond in real time and that can be gamed readily by a handful of large players.
Everyone is applying the rules from the past as if they are germane today, but we've never been in a situation where we are right now, and its highly likely that we're now dancing on the edge of a naked singularity where what we do know is no longer relevant.
Ultimately, a new real economy will emerge, but its not going to look like the old economy except bigger. My guess is that the USD is going to oscillate wildly between strength and weakness before it ultimately collapses, which will wipe out those most heavily invested in the old economy (though it will do a lot of harm even to those who aren't). Stocks are warrants against companies - the stock market will likely shoot to the moon before crashing because shares become too expensive for all but the hyper-rich. Bonds are warrants against infrastructure development, but they don't actually confer ownership, only a share in the maturity interest. If the USD ultimately collapses, these bonds will be worth the paper they're printed on.
However, my guess is frankly just that. If this happens, there will be a few years of dislocation, but ultimately people need to trade, and they will end up using whatever currency has the most stability, most likely one based upon energy production (which is what SDRs are). We've spent decades essentially spending our future productivity, and now the bill is due, and with no effective way to pay it off, there are relatively few long term options. Ask yourself whether the US is capable of growing by a factor of 100 in the next twenty years given fixed resources, ecological limits and an aging workforce. Unless Bernecke has some way of mapping up all of the money that he's shelling out now, it's the interest on the debt that will ultimately kill the USD.
If bankruptcy is the inevitable conclusion, then China's stockpiling of commodities is the correct play... I suspect that something similar is happening among the bailout/bonus recipients... effectively, the treasury is getting ransacked by many robbers... and in the end, no one will care who ran away with the money after we file for bankruptcy... nor will we have the wherewithal to find them. Pretty genius really.
sdrs are NOT based upon energy production....
a currency based upon energy production is the
most useless nonsensical hairball contraption
one could invent....
energy has absolutely no basis for being
money - el zippo...
calls for energy as money are a desperate
feeble and laughable effort to avoid gold....
gold has no peer - none - when it comes to a
money choice....the chinese are preparing their
people for that now....
I choose to raise rates and let the market tank.
That way I can clean out the deadwood and get the money river rolling again.
the most intelligent comment i have read on this
thread....if i had read this first i would not
have written my own redundant comments..
Decent analysis. Assuming that QE expires, that the rotating treasury wash can't continue its spin cycle much longer given heightened political pressures, it may very well prove politically expedient for Obama to wait for a little while before attempting to push QE2. By taking his foot off the accelerator, it will effectively highlight to everyone the fact that the banks, far from being healthy, are walking zombies that are only propped up by the Fed intervention (and may very well suck a significant amount of the life blood from the opposition on health care and related issues).
Longer term, my feeling is that at some time in the next few years you're going to see a global debt repudiation event - a Jubilee at the International level. US QE is bad, but it's still less than either China or Japan, and likely in the long run to be less bad than Germany or England, relative to their respective GDPs. The alternative will be rampant social chaos. Such a repudiation would likely be the national analog to a reorganizational bankruptcy. We're not there yet, but if in fact this continues to play out like the 20th century Great Depression, then at some point it will become imperative for governments to throw up their hands, admit the system is broken, and go into "bankruptcy protection" until it can be fixed.
If I had to guess, I would say that there is no way the Fed is going to quit POMOs. Ben says "no more QE" but he still is buying agencies and MBS. What he meant was "no more QE of Treasuries--for now." I think there is a subtle thing going on with the Chinese: they are selling their agencies but continuing to buy T-Bills. The Fed is buying their agencies.
If Ben completely quits POMOs, we will get a fail. If he raises rates, the economy is completely utterly dead. If he raises rates, the stock market is gonna give up the ghost.
At this point, I think Ben and company are going to choose a large drop in the dollar. I would, if I were him. Let inflation come, let gold shoot skyward, and let long rates rise dramatically. But I would keep doing the POMOs to avoid the fail. I would keep Fed Funds at -0-.
There is no easy way out of this one. I would choose the inflationary route, Door No. 3, if I were Ben.
inflation is not a solution - it leads to the same
place which pomo cessation leads - higher
interest rates....
as currency debasement and inflation take their
tolls the value of the principal falls and
rquires higher rates to maintain equilibrium to
say nothing of gain.....
inflation will also devalue foreign debt holdings
which are quite substantial and brings
foreign policy problems....
anything short of ending fed intervention,
liquidating debt, and raising interest rates
is irresponsible and the same policy mindset
which got us where we are today.
higher interest rates are required to repair
the damange capital structure in this nation
and it will mean lower economic and living
standards for quite some time.
If the central banks intend to let precious metals shoot to the moon then somebody forgot to forward the memo to the bullion banks. Rather than make an orderly exit, the bullion banks have been steadily increasing their net short position to a stupidly dangerous level.
COT data for commercial shorts shows that the net short on PMs, being held by just four bullion banks is:
Silver: 50% of annual mine output
Gold: 40% of annual mine output
This is completely, utterly, mind-bogglingly INSANE. It is physically impossible for these positions to be covered without intervention from a Central Bank, BIS or IMF.
There are massive forces building in the PM war, BRICs vs Central Banks. If the shorts lose this war then precious metal prices are going way higher than anyone expects. Ted Butler makes the point that, given the physical shortage of silver above ground (it has been consumed by industry at a greater level than mine production for many years), that if supply/demand truly plays out, there is even an outside chance that silver becomes more valuable than gold temporarily.
Nice work
One question: Given that we have a fractional banking system where the Fed (and other banks) are only required to actually hold 10% of the deposits, is it not obvious that the Fed will be buying about 10% of all the outstanding US debt?
You write: If the Fed responds to this by extending and expanding its QE purchases of existing public sector debt (either Treasuries or Agency MBS) the dollar will fall like a stone. No one in the global financial community likes this program any longer. If it is allowed to continue there will be a very swift market reaction. There is a lot of dumb money around, but there is not $2 trillion of dumb money to support this.
Well, given the system, the Fed would only need to repurchase about $200 billion of existing treasury debt. This money would then be multiplied by 9 by the banks. Sure, the consumers can't borrow much more, but businesses (CRE) would borrow all they can...
I know what you are saying, but I just can't see how the Fed can screw this one up...
So basically, the Fed, through the banks, which are both owned by the same people, now own most of the property in America.
Now, granted, they ended up overpaying for the homes, since they wrote the mortgages at a much higher value, but in the end it was just written (purchased) with fake credits (USD) anyways, so what do they care how much they "paid"
The previous homeowners will now become tenants, just like the tenant farmers of the depression. Once again, the money creators own everything.
Am I wrong?