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Brad Setser: Follow the Money

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Just who bought all the Treasuries the issued in late 2008 and early 2009?

by Brad Setser
June 12, 2009

As Dr. Krugman notes, the Fed’s flow of funds data leaves little doubt that — at least during the first quarter — the rise in public borrowing was fully offset by a fall in private borrowing. An updated version of the chart I posted last week comparing government and private borrowing can be found on the website of the Council’s Center for Geoeconomic Studies.

Total US borrowing by the non-financial sector (annualized) was under $1.4 trillion in the first quarter — down from $1.9 trillion in calendar 2008 and $2.5 trillion in calendar 2007. In the first quarter, Americans borrowed less, at an annualized rate than they did in 2003.

The federal government borrowed over $1.4 trillion – -and if throw in state and local governments, total public borrowing topped $1.55 trillion. That isn’t a small sum. But households were borrowing (they actually paid down their outstanding debt in the first quarter). And modest borrowing by corporations was offset by a fall in borrowing by noncorporate business. Firms and households combined to reduce their borrowing by a bit less than $200 billion ($184.1 billion). To put that in perspective, households and firms borrowed over $2 trillion in 2006. That is an epic fall.

Borrowing less in aggregate translated into borrowing less from the rest of the world. If the flow of funds is right, the current account deficit in the first quarter in the first quarter was under $300 billion dollars ($293 billion according to table F107). $300 billion is closer to 2% of US GDP than 3% of US GDP. The result, obviously, is less need to borrow from the rest of the world — or to sell equity to foreign investors — to finance the United States import bill.

Who bought all the Treasuries the US government has issued in the last four quarters of data (q2 2008 to q1 2009)? Foreign demand for Treasuries — as we have discussed extensively — hasn’t disappeared, unlike foreign demand for other kinds of US debt. But foreign demand hasn’t increased at the same pace as the Treasury’s need to place debt. The gap was filled largely by a rise in demand for Treasuries from US households.

treasury-demand-q1-09-1

Before the crisis, foreign purchases formerly accounted for almost all new Treasury issuance. Over the last 12 months, foreign demand accounted for more like half of total issuance even as foreigners bought a record sum of Treasuries. And from what we know about the second quarter, I don’t think the basic story has changed.

Central bank custodial holdings continue to rise — just look at the last week’s custodial data. But the world’s central banks are no longer buying up all the debt the Treasury issuing. And Americans are now saving, creating a new pool of funds that needs to be lent out. Moreover, the financial sector isn’t borrowing — it actually is scaling back — which means that the household sector is lending less to financial firms, freeing up funds to flow into the Treasury market.*

Obviously, the price that pulls US investors into Treasuries matters greatly. But the basic sources of demand for the huge amount of Treasuries the US is now issuing aren’t really a mystery.

Paul Swartz of the Council did most of the heavy lifting it took to produce the previous graph. To simplify it, we aggregated Treasuries held by mutual funds with Treasuries held directly by households. At the end of 2008. mutual funds were the main buyers of Treasuries. In q1 2009, though, households themselves were the main buyers of Treasuries (see table F100).

And do also check out Paul’s updated charts tracking the evolution of the current US economic cycle — and how it compares with an average post-war economic cycles as well as the worst (and least bad, if that makes sense) post war slowdowns. They tell an interesting story.

* Total net borrowing (see table F1) fell even more rapidly than borrowing by the non-financial sector, as financial sector borrowing turned deeply negative in the first quarter of 2009. Looking just at “domestic non-financial sector borrowing” in no way understates the fall in total US borrowing.

57 Comments

  • Posted by anon

    “The gap was filled largely by a rise in demand for Treasuries from US households.”

    Also interesting was a near matching decline in household holdings of agency and GSE-backed securities.

    Also, a very large increase in household holdings of corporate and foreign bonds.

    Agency- and GSE-backed securities

  • Posted by Broomhilda

    Flight to quality applied to the US householder, also. Frankly, would you look at the current US stock market and say “Now THAT is a market whose fundamentals I understand, and in which I should be playing!” No way in hell. Essentially, people looked at what is left of their 401(k) and asked themselves which of the 5 options open to them was least ridiculously risky. Everybody is in cash and treasuries waiting for the other shoe to drop.

  • Posted by WStroupe

    Broomhilda said, “Everybody is in cash and treasuries waiting for the other shoe to drop.”

    Yep. To the tune of some $11 trillion or so. Parked on the sidelines.

    But some are starting their engines, and others have already moved to EM investments oriented strongly in hard assets, ’cause confidence is sagging in the dollar’s appeal in an impending environment of inflation. So much for the deflation theory and fears!

  • Posted by Minzu

    Some evil spirit must have manipulated reality in such a way that it has become impossible to write easily commentable posts. Perhaps it is time to consider this:

    http://www.publicaffairslinks.co.uk/vacancies_eu.html

    No need to apply, just marvel at the opportunities in postmodern reality. This is one area where Europe still beats the New World and the very old (and of course venerable) world of China: meaningful jobs without economically measurable output. But notice that these positions are also not very expensive..

  • Posted by FollowTheMoney

    With greater and greater demand things tend to become a bubble? And what rate will households truly be attracted to T-bills? More important, are T-bills attractive if the fed is monetizing debt and devaluing our currency?

    You also make a good point that financial firms are not borrowing. won’t this impact consumer consumption?

    What i’m more curious to know is who’s buying all the equities from march 2009-june 2009? Volcker recently said “the economy is being held up because of the good graces of government intervention”. That’s some pretty strong words from Mr. Volcker. I know the Federal Reserve has been buying Mortgages, secuities, auto loans, etc but in my view it looks like the Fed through some sort of an account at an institution could have been active in the stock market.

    I hope I’m wrong, but i truly have my suspicions based on various flows…If Bernanke lied about threatening Lewis, what else could he be lieing about? I had alot of trust in Bernanke, but after the testimony yesterday my view with him is that he lacks credibility and trust. Once lost, both hard to regain.

  • Posted by Cedric Regula

    Nothing like a stock market crash to make a 0%-1% return look good ! Lucky us. 1Q flow of funds data indicates $1.3 Trillion loss in US personal net worth. $50 Trillion left to get.

    So the real question is how long the US saver will be satisfied with a near zero return on savings/investments, especially with inflation being a credible threat on the horizon.

    We are of course getting a big rally in stocks and commodities since March, and not too surprisingly the Treasury yield curve has been on a steady rise in concert.

    Last two days we got a big rally on the long end. The market apparently took comfort that this weeks offering of $19B in 10s and $10B in 30s were met with good demand.

    What ever makes people happy, but in the context of $9 Trillion more coming over the next 10 years, I find the rally today rather humerous.

    On another note, Summers spoke at the CFR today. I saw parts of it on CNBC. He pointed out all the economic crisis that this generation has seen are due to excessive leverage/risk taking by the financial sector. Bravo !…I’m glad someone noticed.

  • Posted by Too Much Fed

    Could someone make sure I have my columns right and from p.8 D3 of the flow of funds?

    For the last 5 quarters, I get total debt of (in billions):

    50,633
    51,151
    51,985
    52,532
    52,860

    No deleveraging there?

  • Posted by yoda

    need to trash dollar and treasury market for SP500 to go above $1000. Fed/Ben needs to come in with more liquidity!! equity market rally to sun!! eiya!!!

  • Posted by Too Much Fed

    “Firms and households combined to reduce their borrowing by a bit less than $200 billion ($184.1 billion). To put that in perspective, households and firms borrowed over $2 trillion in 2006. That is an epic fall.”

    I would say a LOT of those entities should NOT have been borrowing in the first place.

    You said “epic fall”. Should it be there was an “epic rise” that was ABNORMAL?

  • Posted by yoda

    Ben with his PPT team will show up with newly printed dollar to push equity higher, eiya, equity market rally to sun!!!

  • Posted by Too Much Fed

    WStroupe said: “Broomhilda said, “Everybody is in cash and treasuries waiting for the other shoe to drop.”
    Yep. To the tune of some $11 trillion or so. Parked on the sidelines.”

    Assuming that is correct, exactly how much currency is there?

  • Posted by Alfred

    So foreign demand accounts for roughly half of all treasury purchases. We know the players there as well, mostly China, SEA, Japan. The other half comes from US private households. Does this mean that this time around interest rates in the US are 50 percent less dependent on China’s disposition to lend us money? Even if this is true China’s reign over US government paper is still unhealthy. How about inflation? Can American households to be expected to contribute to low inflation the same way as China did with Greenspan’s conundrum?

  • Posted by WStroupe

    Too Much Fed,

    Probably the cash portion, if you include money markets, is in excess of $7 trillion.

  • Posted by bsetser

    alfred — a rise in household savings (i.e. a fall in consumption) would tend to be disinflationary. and on a forward looking basis, my guess is that share of treasury issuance bought by the rest of the world will fall to about 1/3 (it was $700-800b in the last 12ms of data, and issuance basically reached $2 trillion in q2. the fed will shift from being a net seller of treasuries (as in the chart above) to being a net buyer.

    too much fed — I think I have been fairly clear over time that the run up in household and external debt that the us experienced from 02 to 07 was abnormal. There was an epic rise in demand for say private label ABS backed by mortgage lending.

  • Posted by FollowTheMoney

    Yes, and how far are we the deleveraging for the epic rise in external household debt accumulated from 02-07?

    @ yoda

    is the economy 40% better than it was in March? hmmmmmm nooooooooo

    is the consumer and unemployment 40% better than the state we were in during the month of March? hmmmmmmmmmm nooooo

    In my view, I just don’t understand the need to raise the market unless it was collaboration initiated by banks so they could recapitalize. Whats wrong with deflation? I am a fan of deflation, deflation is good for people who save, invest wisely and live a life of balance of moderation. I’m still in the deflation camp. The problem is I currently reside in a nation built on credit so the policy makers may do anything to reflate a broken model.

  • Posted by Too Much Fed

    WStroupe, OK.

    “too much fed — I think I have been fairly clear over time that the run up in household and external debt that the us experienced from 02 to 07 was abnormal. There was an epic rise in demand for say private label ABS backed by mortgage lending.”

    OK.

    I would like people to give their thoughts about if china was DENIED entry into the WTO then the fed probably would NOT have been able to lower interest rates so far in the early 2000′s to produce so much debt.

    Would there have been less demand for private label ABS backed by mortgage lending under that scenario?

    What else would have happened? Thanks!

  • Posted by Too Much Fed

    FollowTheMoney said: “I am a fan of deflation, deflation is good for people who save, invest wisely and live a life of balance of moderation. I’m still in the deflation camp. The problem is I currently reside in a nation built on credit so the policy makers may do anything to reflate a broken model.”

    What’s wrong with it (price deflation)? IMO & from the fed’s point of view, lower and middle class people will probably NOT go further and further into debt to make up for negative real earnings growth. This will stop the transfer of wealth thru debt interest payments, higher stock prices, and higher housing prices to the rich.

    What gets asset prices really going up? How about higher quantities, higher prices, and higher margins? Negative real earnings growth for consumers and consumer debt provides those three until the consumer can’t make the interest payments and the collateral (if any) falls in value.

    The other thing is that most companies (excluding some semiconductor and some tech) will not expand supply if prices of their product is falling. They may even attempt to cut back on supply to raise prices.

  • Posted by Cedric Regula

    Too Much Fed “The other thing is that most companies (excluding some semiconductor and some tech) will not expand supply if prices of their product is falling. They may even attempt to cut back on supply to raise prices.”

    The semiconductor industry is my favorite example of why price deflation is not the scary bugaboo it’s made out to be. Companies actually expect price declines, and if they are lucky enough to be the market price leader (like Intel) they actually set the pace of declines. But at any rate it’s in the biz model and they deal with it successfully.

    But economists are never clear about whether it’s debt deflation or price deflation that they are in mortal fear of. They can be related, but usually only when some outside event happens that surprises companies with price deflation, they find out they are too leveraged, then they fail, which is the debt deflation part.

    But, what do economists know.

  • Posted by J.R.

    Hi,

    Can you comment on the results of the 30 year auction yesterday?

    Particularly, the 49% indirect bid – is this a significantly strong number, and to what extent can we conclude the 49% is representative of foreign governments/central banks buying the 30?

    Thanks

  • Posted by FollowTheMoney

    @ Too Much Fed/ Cedric,

    thanks for the feedback. I’m looking forward to deflation, I think it’s going to be great. In my opinion I’ve had dreams of Volcker making one list stint at the Fed and raising rates into the double digits.

    I hear alot of arguments against deflation, but whats so bad about falling prices?

    The only thing I question is your accessment that wealthy people are against deflation. I disagree to some extent. why wouldn’t wealthy people like to be on the sidelines and then buy up assets at lower prices, once the final collapse has occurred?

    iny my view, the current administration to trying to reflate a broken a model. I think it’s sad that neither the Fed nor the Treasury just wants to soak it up for a few years. Ok, sure we get a quick glimpse of maybe 20% UE, but at least we’ll come out of it stronger.

    The current path we’re on is going to collapse the savings of all those who have lived a modest life. I feel bad for them, not everyone understands inflation (years out), or the consequences. 10 years ago you could buy a Snickers for 35 cents, today it’s almost a dollar. It’s really sad for people who dont understand the market, or those that can’t hedge. I feel bad, it’s policy all around. and it’s goin to get far worse as we try to inflate our way back to 2007…

  • Posted by Cedric Regula

    FollowTheMoney:”I feel bad, it’s policy all around. and it’s goin to get far worse as we try to inflate our way back to 2007…”

    When everyone has mortgaged the farm to buy treasuries, then we will know we have successfully left the 1930s and are firmly grounded in the 1920s. Except that we will have a treasury bubble instead of a stock bubble.

  • Posted by jimbo

    A lot of muddled thinking here. Treasuries are only an alternative to reserves or cash – there can’t be a “move out of” stocks or corporate bonds into them (all that does is move money around and cahgen the price of those other assets). When the U.S. spends more than it taxes, reserves build up in the banking system. The only way they can be drained is for them to be exchanged at the Fed for interest-bearing securities. Since most people would rather earn interest (however low) than not, most beyond the basic requirements of the banks ends up converted into treasuries. That’s pretty much it. There will always be a demand for any amount of debt the U.S. gov. issues, because the only alternative is non-interest bearing reserves.

  • Posted by bsetser

    jimbo — except right now bank reserves earn interest, and banks have been building up large reserves at the fed …

    JR — don’t know. would need to find out who other than central banks are part of the indirect bid. Someone obviously bought. A lot of CBs cannot go out that far, and the details of the survey data (from june 08) suggest that only 4% of total treasury holdings by CBs exceeded ten years. On the other hand, as CB reserve managers (actually a few asian reserve managers, but especially SAFE) shifted into Agency MBS, the maturity profile of their Agency portfolio rose, with holdings of long-term agencies going from 20% of agency holdings to 40% from mid 06 to mid 08 (a period when total CB holdings of agencies soared). so there is capacity to go out the curve at the right price.

  • Posted by WStroupe

    brad, and JR:

    Maybe China bought a minimal (as compared to what it used to buy) sum of the 30-year Treasuries yesterday mostly so that it could put some downward pressure on yields? It’s in China’s interests to do enough to keep the yield curve from getting out of control, while at the same time not significantly increasing its exposure to the long-dated Treasuries. And maybe when the TIC data comes in for June, we’ll see that China was selling some long-dated Treasuries at the same time it was buying a few.

  • Posted by Cedric Regula

    Brad:”JR — don’t know. would need to find out who other than central banks are part of the indirect bid.”

    I always hear bond traders and reporters refer to this category as the “large institutional and central bank buyers”. So I guess that would cover banks, pension funds, insurance companies, swfs, and CBs.

    I was looking around the official Treasury site yesterday looking for a better description than they give on the post auction press release, but couldn’t find any more breakdown than that.

  • Posted by jonathan

    Just a note of appreciation for Paul Swartz’s amazing charts.

    The historical ones showing the GD and prewar are fascinating.

  • Posted by guest

    Agree to this token of appreciation to P Swatz charts.Could it be possible to plot more information as additional graphs (covering the same period)?

    Total credit exposure compared to GDP
    Breakdown of the industrial/consumption contribution to GDP
    10 years yield
    Current account

  • Posted by guest

    Sorry one should read Paul Swartz and not Swatz

  • Posted by Scott Peterson

    Brad,
    Just wondering if you would care to comment on the incident of the Japanese suitcase with $134 billion in it?
    According to the US Treasury’s TIC data, Japan had $661 billion in Treasury bonds total in Feb 2009. So these guys were carrying the equivalent of a significant proportion of Japan’s total foreign reserves in a suitcase. 20% of the total that US Treasury shows. To put it in perspective, Russia’s total holdings of US Treasuries per the same source is $130 billion.

    It’s either the biggest counterfeiting bust in history or something else…I don’t know what.

  • Posted by Indian Investor

    Perhaps the US Federal Reserve counterfeited its own bonds to the tune of $134 billion and handed the counterfeit bonds to the Japanese Secret Service. The Japanese were supposed to take those bonds to Switzerland, where the counterfeit bonds could have been deposited as ‘Federal Reserve custodial holdings’ of foreign Central Banks. The Japanese guys goofed up by wearing blue suits and dark sunglasses, with mirror-shine shoes and shoulder-holster guns in a local Italian train, and hugging close to their suspicious suitcase. The poor Japan Interior Minister was caught red handed. How can the Bank of Japan accept counterfeit bonds from the US Federal Reserve, that too without Taro Aso being fully in the loop? So, he had to go, on some other pretext.
    This explains the curious rise in the Fed’s custodial holdings.

  • Posted by WStroupe

    Maybe the $134 billion in US bonds were genuine and were being smuggled by Japan’s central bank into Switzerland to exchange them for francs, all while Japan’s finance minister was saying Japan’s confidence in US Treasuries is “unshakable”. Ok, so it’s a bad joke. But wouldn’t it make a great political cartoon on falling confidence in the dollar? Anyone here a good cartoonist?

  • Posted by K T Cat

    “the rise in public borrowing was fully offset by a fall in private borrowing”

    That’s an upbeat restatement of the problem. We’re in a balance sheet recession and, thanks to government borrowing, our aggregate balance sheet has gotten worse. Public borrowing represents a reduction in future earnings since public borrowing will not lead to higher profits later. Until we begin to deleverage in the aggregate, which we are not yet doing, we won’t get out of this recession.

    Meanwhile, interest rates are going up prior to economic growth as the Treasuries require higher and higher yields to clear out the auctions. That the auctions haven’t failed and we still have entities willing to buy the things misses the point illustrated by the rise in interest rates.

  • Posted by K T Cat

    From those wonderful charts you linked to comes this:

    Real economy indicators show signs of stabilization. See in particular the charts on manufacturing sentiment, nonfarm payrolls, oil prices, and car sales. Nonetheless, many of these indicators remain worse than anything hitherto experienced in the postwar period.

    The collapse in the federal government’s finances is unprecedented, raising questions about how the government deficit will be brought under control.

    We’re borrowing a lot more with no indication that the economy is growing to service the new debt.

    Maybe those successful Treasury auctions are a bad thing as they allow us to delude ourselves that all this debt is still OK.

  • Posted by WStroupe

    K T Cat said, “Meanwhile, interest rates are going up prior to economic growth as the Treasuries require higher and higher yields to clear out the auctions. That the auctions haven’t failed and we still have entities willing to buy the things misses the point illustrated by the rise in interest rates.”

    K T Cat also said, “Maybe those successful Treasury auctions are a bad thing as they allow us to delude ourselves that all this debt is still OK.”

    Spot on! This is just the kind of coherent, stark, sensible analysis of the bigger picture that we need here.

  • Posted by Indian Investor

    For the US economy, you need to calculate the total debt level, the total annual debt servicing outflow, and the GDP. With these three numbers you can determine whether a recovery is likely. I reasoned before that there isn’t too much of a problem in terms of the US Treasury going bankrupt from an external financing perspective. But that is heavily influenced by the above three numbers. Credit deleveraging and GDP contraction are probably going to go on.

  • Posted by gillies

    that ‘everyone is on the sidelines’ image has to be a false one.

    i think it was well explained here before -

    ‘everyone’ who sold shares to hold cash found someone who raised or borrowed cash to buy the shares – so there is another contrarily minded ‘everyone’ in there somewhere . . .

  • Posted by K T Cat

    Spot on! This is just the kind of coherent, stark, sensible analysis of the bigger picture that we need here.

    You may subscribe to my weekly newsletter for the modest price of $12.99 per issue! If you order now, we’ll throw in a handsome totebag and travel mug!

    :-)

  • Posted by gillies

    deflation lovers ! come and live in ireland. our latest published inflation figures (remember we may not calculate them as you do) are minus four and a half per cent.

    going down . . .

  • Posted by anon

    “Borrowing less in aggregate translated into borrowing less from the rest of the world.”

    The first is true; the second is true; but the connection is too simplistic.

    e.g. total non-financial borrowing decreased by $ 700 billion from 2008Q4 to 2009Q1 and by $ 1.3 trillion from 2008Q3. The correlation of these changes with estimated CA deficit levels is poor.

    Using total borrowing including financial borrowing, this decreased by $ 3 trillion from Q4 to Q1. Obviously a distortion. But double counting isn’t a valid reason to exclude financial borrowing, as there are flows between non-financial sectors as well as financial sectors.

    The problem is that credit flows exclude too many non-credit items to make reconciliation reasonably accurate and reliable.

  • Posted by gillies

    those two men were sent over the swiss border with one false bottomed bag, because 134,000 japanese carrying a million dollars apiece would have been too obvious.

  • Posted by Observer

    Quick question for Brad:

    I understand the flow of funds shows net borrowing/lending by the different sectors. How would the re-lending of funds raised by the USG show up under such data? For example, there’s obviously the Federal soft loans to financial institutions like AIG and Citi. What about the Fed’s purchase of ABS? Does that show up as private borrowing?

  • Posted by Alfred

    But if the Fed soaks up the remaining Treasuries and becomes a net buyer isn’t that like monetizing debt and therefore inflationary? The Fed is saying they are not going to do that. I understand that less consumption is putting some slack in the economy and is therefore disinfaltionary. Against conventional wisdom I believe that we had rather high inflation in the last 15 years or so. The unique situation in China, its currency peg and a significant trade imbalance, causing remarkable savings which were then reinvested to buy US government paper. This (Greenspan’s conundrum) and cost pressure from imported goods from China and other EMs kept IRs artificially lower as they shoud have been. So I guess what I am getting at is that if China is abel to soak up only about 50 percent of Ts issued we will get higher infaltion down the road no matter what the Fed is doing. Maybe even hyperinflation.

  • Posted by WStroupe

    Alfred said, “So I guess what I am getting at is that if China is abel to soak up only about 50 percent of Ts issued we will get higher infaltion down the road no matter what the Fed is doing. Maybe even hyperinflation.”

    Depends, for one thing, on whether domestic U.S. savers can make up for losses of CB purchases while all the massive new issuance also arrives. If U.S. investors do too much diversification, as Bill Gross warns them to, and buy hard assets too, then maybe the Fed will have to pay ever higher yields, and then we’ve got big problems down the road.

    I have serious doubts that U.S. savers can/will step up to the plate to sufficiently resolve the escalating yields issue. What the hell are they waiting for?

  • Posted by Indian Investor

    WStroupe: Depends, for one thing, on whether domestic U.S. savers can make up for losses of CB purchases
    Me: The more the ‘US Savings’ go up, the lower the US GDP gets. Improvement in the US external balance is a direct result of the fall in aggregate US demand. As Brad has pointed out, that improvement isn’t coming from increased exports, say, to China. Consumers have paid down $200 b of debt, down from an annual increase of $2 trillion previously. Most of the ‘savings’, I think, are allocated to pay down existing debt, and to avoid borrowing more. Meanwhile, there’re steadily decreasing opportunities to save. The GM bankruptcy will cause around 200,000 job losses, when you add in the 14 factory closures, 40% reduction in hourly wage workers, more than 50% closure of dealerships, and the impact on employment in GM vendors.
    The current rally is on the back of FAS157 changes, that allow a bond that’s worth 37 cents to be held by banks at $1.00, and with them demanding bids at a minimum of 99 cents through the PPP route.
    Once the employment data for June and July kicks in, you’ll see a major correction.
    It may take anywhere from 2 to 4 years of GDP contraction ahead, before the US economy reaches a steady state, in which some of the accumulated debt burden from the past has been paid down, and there is room for consolidation and expansion of debt again.

  • Posted by Ying

    Is stagflation instead of inflation possible? Unemployment rate seems to continue to get worse in the near future. If inflation rate starts to go up because investors move into real assets, that will leave little room for monetary authority to act.

  • Posted by Larry

    Yes, private borrowing has declined, and has been mostly replaced by public borrowing. But we know that public borrowing isn’t sustainable at anything like current levels, and that private borrowing isn’t going to come back to its previous level, because private borrowers got way overleveraged.

    Doesn’t that mean that the public borrowing binge is only going to delay the transition to a less-leveraged economy? Does it have other effects that we really want?

  • Posted by Kafka

    The fed, fantasy or reality, I say fantasy which psychologically impacts reality (if such a thing exists) from which immense profits can obtain. I told you guys 10 year rates would rise months ago based on the fantasy created by the Fed and the Politicos insipient portention to deficit spend to fund their self interested earmarks and special interest projects. Simple math with immense profits. Rates will continue to go up, no other result can obtain. You can pretend the Fed is real but all that is occurring is the Fed is flooding the markets with dough to be reinvested in treasuries, it is called round robin where I come from. Deflation is the enemy of the Politicos as it reduces tax revenues which makes the business of being a Politico unprofitable, controlled inflation is the name of the game and that is what they pray to their money gods for every night. Will it work, maybe for a time but not over the long haul, no empire has been able to sustain such massive deficits just like all good ponzi schemes, it eventually ends and from that you can profit.

  • Posted by WStroupe

    Ying said, “Is stagflation instead of inflation possible? Unemployment rate seems to continue to get worse in the near future. If inflation rate starts to go up because investors move into real assets, that will leave little room for monetary authority to act.”

    Precisely. The stagflation scenario is still seen as likely by a minority of experts, but that minority is growing fast. The escalation of yields and interest rates carries many powerful negative implications for the real economy and for the U.S. ability to return to growth. It could even be worse – it could turn out to be shrinkflation, where the economy continues to contract (not just stagnate) while inflation rages.

    Let’s say global investors do keep giving the nod to hard assets – that portends that the U.S. will have to import inflation from abroad, and it could be a very potent inflation. The world’s lenders aren’t piling into longer-dated Treasuries so as to keep interest rates/yields low. This thing could feed upon itself – I think it already is doing so. The higher yields/interest rates go, the greater the inflation expectations and the more investors sell off dollars for hard assets as a protection. That only sends the dollar lower and feeds back into the cycle all over again.

    The effects upon the real economy of the U.S. show up a little later – higher mortgage rates, killing the refi boom idea, pressuring house prices lower, hitting consumer sentiment and spending harder, business failures and layoffs, more foreclosures, and over and over again – serious, ongoing contraction. One assumes the situation will eventually prod the gov to spend yet more and more, and there you have the real economy feedback into gov spending and hitting the dollar and Treasuries even harder – self-reinforcing cycles galore.

  • Posted by Cedric Regula

    I think the two choices are stagflation or shrinkflation. But we have to qualify what is meant by “inflation” since the concept has been tortured to death by government economists. If they would re-name “core CPI” to “Chinese Toaster Oven Inflation”, then the average non-economist on the street could get a better handle on what the Gov is talking about. Then Joe English Muffin would also have to understand that if the Chinese decide to put LCD displays on toaster ovens as an excuse to raise prices, our economic know-it-alls will say that is an “improvement in quality” and therefore the price did not go up for the purposes of calculating inflation.

    So that is how far we’ve come with modern economics.

    The Stag or Shrink part is easier to get your head around. The Fed always says they try to maximize the economy’s potential, while maintaining price stability(CPI growth at 2%, but see above definition). So they totally blew the maximum potential part since clearly we were well above maximum sustainable potential for most of the decade.

    Just so I don’t get blasted by Krugman for not knowing about liquidity traps, and that inflation is unlikely if you are in one, I will state that I think we have a liquidity trap inside a credit bubble. I also think that in addition to having the situation of banks unwilling to lend, the saner portion of our consumer and business population may be unwilling to borrow. This is probably a more mutual kind of feeling than Keynes proposed back when he discovered the liquidity trap.

    So this argues that we should have a long period of the economy operating below sustainable “potential”, due to de-leveraging at all levels of the economy(except government, obviously).

    But getting back to the inflation part, we once again have speculators driving up all commodity markets. Theory says this can’t happen for long if demand isn’t there, but here I’ll take the opportunity to remind Krugman of his “backward bending supply and demand curves”. This is where producers realize they can make more money by doing less. So I think we may get producers cutting back in the face of higher prices, which helps support higher prices over the long haul. In the short term we will probably see commodity traders beat each other up with saw toothed charts, but the slope is upward.

    Then a new source of inflation will be Cap and Trade. Ever since we discovered fire, we know that cheap energy is the foundation of higher standards of living. We are about to change that.

    Then we have other things that will increase the cost of living, leading to less discretionary spending, which in turn would moderate Chinese Toaster Oven Inflation. We can decide if that sounds good or not.

    One of those things is higher Federal taxes. But watch out, state and local governments need them too. We are trying to maintain government spending in the face of falling GDP, so that means more tax burden for the private sector.

    Then the non-competitive portions of our economy, the ones that have pricing power, will try to increase prices/incomes to keep up with rising costs. These would include the healthcare industry, legal professions, and probably the cable company. This is not an exhaustive list however.

    The dollar does still need to weaken to correct trade imbalances. So the ever present question is whether China and/or ROW decides to de-couple from the buck. Import inflation is the consequence then. But so far most of the CBs around the world have taken the opportunity to match printing press speeds with the Fed. So “adjustment” just never seems to get here.

    Then there will be higher financing costs at government, business and consumer levels.

    I probably missed a few things, but the above seems like enough.

    *Disclaimer…I’m not trying to pick a fight with Krugman. I know he’s smarter than I am, can do calculus better than me(even though I had 5 semesters of it in college), and he knows 100 times as much as I do about economic theory. Besides he likes beer so he seems like an OK guy. See the photo in his blog where he is poised to down what appears to be a Guinness Stout.

  • Posted by FollowTheMoney

    Oil should hit ~$80 on this run and then reverse, so I’m not sure investing in commodities at these levels is ideal (especially with more global contraction ahead).

    I’m curious if the 134B in Tbills 2 japanese had with them are legit? And why is there no mention of this on CNN? Wouldn’t that be 1/5th of Japans reserves??? Counterfeit or not, this is a pretty big deal. Is it not?

    Pimco stated this weekend it expects the Fed to buy even more Tbills. At this point the FED is surely playing with fire in hoping to contain low interest rates. In my opinion, The crisis throwing the world into a greater global recession in Q3-Q4 may involve the dollar…

    If there is one commodity or two commodities that are attractive instead of Tbills i think one has to buy GOLD and SILVER. I’m not precious metals bug, but if we’re going to have currency devaluation wars and a Fed that’s looking at the trees in CENTRAL PARK to increase dollar reserves I think owning a bit in A or B would be wise.

    Also don’t forget the house voted to the AUDIT the Fed this weekend. This is pretty big news, and if the public gets a look at the balance sheet, who knows? We maybe for ‘panick’…

    Just a thought.

  • Posted by gillies

    in a contracting global economy would not high commodity prices resulting from a ‘flight to safety’ rather than industrial growth – be highly deflationary ?

  • Posted by Cedric Regula

    gillies:

    The price of Chinese Toaster Ovens will fall until the CTO Price + Chinese export subsidy per unit = Iron Ore Price per unit.

    Once prices plus subsidy fall to less than the Iron Ore Price per unit, they will cease production and there will be no more toaster ovens. Unless of course the USG offers a tax credit to support toaster oven price levels. This may of course be in the form of a Cap and Trade credit which consumers may redeem for cash at the Chicago Merc Exchange(minus trading commissions and fees, of course. It will also taxable at your income tax rate).

    I expect Krugman will come up with a better model than I’ve sketched out here.

  • Posted by Jason

    How do households buy treasuries Brad? Is it indirect through bank deposits or direct bids?

  • Posted by Cedric Regula

    Jason:

    Retail investors can buy up to $30K/year direct from the treasury with no fees and commisions that brokers would charge. But I expect that many do it by buying bond funds or bond ETFs.

    http://www.treasurydirect.gov

  • Posted by jimspassion

    K T Cat
    Real economy indicators show signs of stabilization. See in particular the charts on manufacturing sentiment, nonfarm payrolls, oil prices, and car sales.
    Nonetheless, many of these indicators remain worse than anything hitherto experienced in the post-war period. The collapse in the federal government’s finances is unprecedented, raising questions about how the government deficit will be brought under control.
    We’re borrowing a lot more with no indication that the economy is growing to service the new debt. Maybe those successful Treasury auctions are a bad thing as they allow us to delude ourselves that all this debt is still OK.
    I agree delude ion is a major problem and we don’t have any creditable benchmarks to work with all comparisons’ seem to differ- it’s hard to pin point like with like – my sources in AU have continued to paint a bleak picture of shipping things are very quiet (don’t believe all you hear that AU is avoiding recession) ships are going in and ships are going out yes but with a lot of empty containers on board.

  • Posted by bsetser

    I’ll let paul know you appreciated his hard work on the charts; I also think they are quite good. We will consider adding a few more.

    Jason — don’t know, really. it wasn’t through mutual funds (separate line item). good question though. I simply am reporting the data from the flow of funds.

    Larry — tis a bit more complicated. By sustaining demand, the government’s borrowing keeps private income up and thus facilitates true deleveraging. if you pay down your debt but your income falls more, your leverage doesn’t fall. and if a bank prunes its balance sheet but its losses cut its capital more, its leverage doesn’t fall. this was one of Keynes insights i think — namely that in the absence of government intervention, a self reinforcing downward dynamic can impede effective deleveraging. that said, there is no question that the public sector’s debt — and thus its leverage — is rising.

  • Posted by denarius

    Alfred – “But if the Fed soaks up the remaining Treasuries and becomes a net buyer isn’t that like monetizing debt and therefore inflationary? The Fed is saying they are not going to do that.”

    News flash: The Fed are a bunch of lying puss bags. Pictures at 11…

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