About the only bubble currently inflating at the moment is the market in U.S. T-Bonds. Most other bubbles have burst: housing, gold, commodities, stocks. As New York-based Alexei Bayer points out in today’s Moscow Times, investors with cash in hand are seeking safety and about the safest thing at the moment are government bonds, colloquially known as ‘T-Bonds’ or ‘Treasuries’. As you would expect because demand is high, the rate the government has offered has gone down and down. Sales of government securities are currently providing the cash that our government is using to bail out the economy. But T-Bonds are a major part of the portfolios of countries like Russia and China.
And Russia and China will likely liquidate some of these holdings to fund their own internal stimulus programs. China has already announced a $565 billion package. Russia will likely dig into its own reserves as well (down to $485 billion from over $600 billion a month or so ago). Then the fun begins:
This may be the start of a global avalanche, since other central banks have been drawing down their reserves as well, albeit by smaller amounts. Further down the road looms China’s $586 billion fiscal stimulus package, which will be financed by the liquidation of U.S. Treasury securities that the country’s government and central bank hold.
Even as world central banks stop buying U.S. T-bonds and start selling them, demand for funds in Washington is escalating. The federal budget deficit reached a record $237 billion in October alone. In fiscal year 2008, which began Oct. 1, it will widen to at least $1 trillion. Washington will need to raise $1.5 trillion in the current year, according to U.S. Treasury Secretary Henry Paulson. It is safe to assume that Paulson’s estimate is a conservative one.
Driven by rising supply and falling demand, yields on U.S. government bonds may spike. This will cause interest payments, which currently measure some $450 billion per year, to skyrocket. The worst-case scenario would be if the United States finds that it can’t borrow what it needs at any price — the same situation many consumers and companies already face in the current credit crunch.
And the Fed’s solution when faced with a credit freeze? Print money:
Since the dollar is a reserve currency, the problem with printing dollars is that the subsequent inflation will be instantly transmitted abroad. At the start of this decade, for example, no nation could escape a liquidity bubble once the U.S. Federal Reserve began pumping dollars into the world financial system. If Washington starts printing extra dollars, foreign central banks will either be forced to revalue their currencies sharply against the greenback — and thus worsen the already nasty recession at home — or issue more domestic currency to match the depreciating dollar.
It seems like a plausible scenario but one with no good choices: if the scenario doesn’t come to pass, we have increasing deflation. If it does, then we’re facing inflation:
For now, most economic forecasters around the world still expect falling prices next year. Consumer prices in the United States fell by a dramatic 1 percent in October. But this will change quickly if the Treasury bubble bursts and the U.S. government is forced to start up the dollar printing presses.
Read the whole thing. All I can say is that I hope Bayer is wrong. I’ve always thought of the U.S. as the responsible country in the world – not as an oversized Argentina.
Twitter
Facebook
RSS
LinkedIn