01 May, 2011

Have We Hit The Real Debt Ceiling Already?

Forget that debt ceiling vote coming up in Congress. The problems are worse.

As Megan McArdle points out:

In response, during a recent summit, the leaders of Brazil, Russia, India, China and South Africa (the BRICS) announced that they want to trade between themselves in their own currencies. This comes amid a growing chorus in China pushing for a limit of dollar reserves to $1.3 trillion. At present, China, whose economy the IMF says will outpace that of the US by 2016, has $3.04 trillion in dollar reserves. What's going to happen to the dollar when China sells off $1.74 trillion? And who, besides the Federal Reserve, is going to buy our bonds?
If anything, I think this understates the problem.  The real issue starts, not when China starts selling our bonds, but when China stops buying our bonds. As soon as that happens, we're in big trouble.

Exactly. China is the biggest purchaser of our debt (with one recent exception, which I’ll cover in a moment). If they stop buying, what will we do then? You think Japan is going to buy more, with their problems? Not a chance. Egypt, India, France? Yeah, right.

Right now, when Treasury goes to sell new bonds, it enters a fairly robust market, with not just the Fed but a bunch of fairly price-inelastic Asian central banks who are willing to take on our bonds at whatever the market offers.  If China exits the market, we will either need to borrow less, or attract new lenders by offering higher interest rates.  Even a noticeable decrease in volume would force us to pay more for our deficits.

And since we can’t afford our deficit, we’d have to sell yet more bonds, increasing our debt even further and further increasing the pressure on the dollar and pressure on our buyers.

It won’t matter how high we raise our debt ceiling, if we can’t get anyone to buy our debt.

As Ed Morrissey says:

We are rapidly approaching a moment of truth.  While we debate the finer points of raising debt limits and calculating just how many hundreds of billions of dollars in annual deficits we’ll tolerate, the truth is that the money to fund any deficit spending may soon run out.  Fiscal sanity may wind up being imposed on us if we don’t choose that path willingly.

However, Morrissey may be optimistic. We may be already there.

I mentioned earlier that China has not been the largest purchaser of U.S. bonds lately. It’s been someone else.

From Mark Steyn:

My weekend column is about “the debt ceiling” and how, even as the Treasury issues more and more debt, there are fewer and fewer people willing to buy it. I forgot to mention the really startling number. Pimco (which has now dumped US Treasuries) estimated last month that, under QE2, 70 per cent of the US Government’s debt is being bought by the Federal Reserve.

Ah yes, QE2 rears it’s ugly head again.

We’ve been buying our debt because no one else is willing to buy it. QE2 ends in June. What happens then? Someone asked this earlier.

And if it doesn’t work, what do we do then? Print even more money? What’s the end game here? Where will all this money printing on an unprecedented scale take us? Do we have any guarantees that QE2 won’t be followed by QE3, 4, and 5, until eventually – inevitably – no one will want to buy our debt anymore? What happens if the Fed becomes not just the buyer of last resort, but the buyer of only resort?

And, as I pointed out at the time and almost two years ago:

So the problem is the debt-to-GDP ratio. There are exactly four ways to reduce it. I suspect that we’ll have to do at least two of them.

1) Grow the economy

2) Cut spending

3) Increase taxes

4) Print money

I’m no Nobel Laureate, but if there’s another way, I sure don’t know about it.

Let’s assume that we’re not going to buy our way out of this by printing obscene amounts of money. You get double and triple digit inflation that way and destroy the economy. Generally, that’s a last resort. And usually fails in any event.

Everything Obama has tried has failed at #1. He’s utterly opposed to #2, and the economic situation and the new Congress makes #3 out of the question. We’re now left with #4, the one that I assumed at the time we’d not be stupid enough to attempt.

If no one will buy our debt, #1 & #3 won’t work anyway. Don’t solve the problem fast enough. We could do #2, but we’d have to do it harshly, completely ending programs, not just reforming them. Again, all we’re left with is #4.

Repeating that someone’s words, for emphasis:

Do we have any guarantees that QE2 won’t be followed by QE3, 4, and 5, until eventually – inevitably – no one will want to buy our debt anymore? What happens if the Fed becomes not just the buyer of last resort, but the buyer of only resort?

We may find out the answer to that question very soon. And it won’t be pretty. November, 2012 may be too far away to solve our problems. We may not make it until November, 2011.

Yes, my posts have been incredibly pessimistic lately. I admit it. Hope and change? I’ve lost hope. And I don’t think change can come soon enough.

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