Something to Believe In

Something to Believe In

“Congress is going to have to raise the debt limit,” said Treasury Secretary Timothy Geithner on Sunday’s Meet the Press.

Poor Timothy Geithner.  Aside from the President he must have the worst job in the world.  What could be worse than presiding over the world’s reserve currency at just the moment it blows up?

No doubt, Geithner’s fighting an uphill battle.  His number one product – the U.S. Dollar – has been diluted down like an over breaded meatloaf.  Both its quality and reputation have been compromised by years of moronic fiscal and monetary policy.

On the fiscal side, the government’s run up a $14 trillion debt.  On the monetary side, the Federal Reserve’s artificially suppressed the cost of money and, if you can believe it, they’ve loaned out trillions of dollars they never had to begin with.

Now, after years and years of pushing the tab out into the future, the bill’s due.  In fact, according to Geithner the government will reach its $14.3 trillion debt limit by May 16.  What’s more, the Congressional fight to raise the debt limit may last longer than the money does.

Who Will Lend the Government Money?

Regardless, even if Congress does raise the debt limit who is going to lend the government money?

“China, the biggest buyer of U.S. Treasury securities, trimmed its holdings for a fourth straight month in February and Japan boosted its holdings one month before a devastating earthquake hit the country,” reported AP last Friday.

“China cut its holdings by $600 million to $1.15 trillion, the Treasury Department reported Friday.  Japan, the second-largest foreign holder, boosted its holdings by $4.4 billion to $890.3 billion.  There have been concerns that the March earthquake and tsunami may cause Japan to scale back its purchases in order to use the money for reconstruction.”

Of course the biggest lender to the Treasury hasn’t been China or Japan; it has been the Federal Reserve – and they’ve been loaning out deceitful money they borrowed into existence from themselves.

According to Bond King Bill Gross, “nearly 70% of the annualized issuance since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys – the Chinese, Japanese and other reserve surplus sovereigns.  Basically, the recent game plan is as simple as the Ohio State Buckeyes’ ‘three yards and a cloud of dust’ in the 1960s.  When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them.”

Something to Believe In

As we noted above, the Fed gets the money to buy bonds from nowhere in particular.  They just write a check to themselves and then loan the money to the Treasury.  But, if you hadn’t heard, that racket – also known as QE2 – is set to expire sometime in June.  What happens then?

When the Federal Reserve stops purchasing Treasury bonds the price of money will rise.  In other words, lenders will demand more in return for their bond purchases.  Yields will rise to compensate lenders for purchasing degraded assets.

At the same time, when yields rise, stocks will fall.  When the sea of Fed liquidity is withdrawn from the markets stocks and other assets will recede with it.  If there’s any consolation, this will help to lower gas prices.

However, when panic sets in and unemployment begins to go back up, the Federal Reserve will do what they always do.  They’ll push more of their cheap and easy credit back into financial markets.

What we mean is there will be another round of QE.  For when it comes down to it there is no Fed exit strategy.  The simple fact is the economy cannot survive without monetary stimulus.  Take away the artificial money and the economy wilts faster than a rose in a summer heat wave.

Yesterday, sensing the end is nigh, Standard & Poor’s lowered its long-term outlook for the federal government’s fiscal health from “stable” to “negative.”

“Our negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years,” said Standard & Poor’s credit analyst Nikola G. Swann.  “The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.”

In other words, the marketability of U.S. government debt as a financial asset is doomed.

“I enjoy these challenges,” said Geithner.  “I believe in them.”


MN Gordon
for Economic Prism

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