Something to Believe In
On a recent episode of Meet the Press, Treasury Secretary Timothy Geithner stated, “Congress is going to have to raise the debt limit.” It’s a daunting responsibility he bears, one that ranks among the most challenging positions alongside the President. To oversee the world’s reserve currency amidst a looming crisis is no easy feat.
Geithner finds himself in a precarious situation. The U.S. Dollar, his primary asset, has been devalued significantly, much like an overcooked meatloaf. Years of misguided fiscal and monetary policies have tarnished both its quality and reputation.
On the fiscal front, the government has accumulated a staggering $14 trillion in debt. Meanwhile, the Federal Reserve has kept interest rates abnormally low and, incredibly, has lent out trillions that it doesn’t actually possess.
After years of postponing the reckoning, the bill is now due. Geithner warned that the government is expected to hit its $14.3 trillion debt ceiling by May 16. Additionally, the contentious negotiations in Congress over raising the debt limit may extend beyond when funds run out.
Who Will Lend the Government Money?
Even if Congress does decide to raise the debt limit, a pressing question remains: who will finance the government’s spending?
As reported by AP last Friday, “China, the largest purchaser of U.S. Treasury securities, has reduced its holdings for the fourth consecutive month in February, while Japan increased its investment just before a devastating earthquake struck the nation.”
“China cut its holdings by $600 million, bringing it to $1.15 trillion,” the Treasury Department indicated. “Japan, the second-largest foreign holder, raised its investments by $4.4 billion, totaling $890.3 billion. Concerns have arisen that the March earthquake and tsunami may lead Japan to limit its purchases for reconstruction funding.”
Ironically, the Federal Reserve has emerged as the largest lender to the Treasury, providing funds that were essentially fabricated. As Bill Gross, known as the Bond King, pointed out, “almost 70% of the annualized issuance since the beginning of QE II has been acquired by the Fed, with the rest falling into the hands of traditional buyers like China, Japan, and other sovereign nations with surplus reserves.”
Something to Believe In
The Federal Reserve obtains the capital to purchase bonds from thin air. They essentially write themselves a check and extend the loan to the Treasury. However, this scheme—known as QE2—is set to conclude sometime in June. What will be the consequences?
Once the Federal Reserve halts its bond purchases, the cost of borrowing will rise. Lenders will seek higher returns for their bond investments, leading to increased yields to make up for the declining value of these assets.
As yields rise, stock prices are likely to fall. The withdrawal of Federal Reserve liquidity from the markets will cause stocks and other assets to decline. If there’s a silver lining, the result could be lower gas prices.
Nevertheless, when fear grips the markets and unemployment rises once again, the Federal Reserve will inevitably act in its customary manner. More cheap and easy credit will flow back into financial markets.
What we’re ultimately facing is another round of quantitative easing. When it comes down to it, the Federal Reserve lacks a true exit strategy. The economy simply cannot function without ongoing monetary stimulus. Take away this artificial support, and the economy would wither away faster than a rose in a summer heatwave.
In response to these imminent crises, Standard & Poor’s downgraded its long-term outlook for the federal government’s fiscal stability from “stable” to “negative.”
According to credit analyst Nikola G. Swann, “Our negative outlook on our rating on the U.S. sovereign indicates that there is at least a one-in-three chance we could downgrade our long-term rating within two years. This outlook reflects our view that political negotiations regarding both medium- and long-term fiscal challenges will likely persist until after the national elections in 2012.”
In essence, the financial viability of U.S. government debt appears to be on increasingly shaky ground.
“I enjoy these challenges,” Geithner said. “I believe in them.”
Sincerely,
MN Gordon
for Economic Prism