Shelter from the Storm
The US Treasury’s borrowing needs are about to explode, as we wrote last week, and for more reasons than growing deficits.
Consider the convergence of some of the contributory factors:
The Fed has proposed that it will clean up its balance sheet, swollen by Quantitative Easing (QE), with Quantitative Tightening (QT). That means when bonds in its portfolio mature, the Fed isn’t rolling them over into new bonds as it had done along the way during the QE phase of its operation. But the Treasury can only redeem bonds today – including the Fed’s maturing bonds – by selling new bonds tomorrow. The net effect of QT is that a much bigger supply of bonds needs to be absorbed by a straining market. For 2019, the Fed planned to reduce its holdings by $600 billion.
At the same time, and as we have been warning, the global dollar reserve standard is winding down. In 2000, 72 percent of global foreign exchange reserves were in dollars. Now it is only 62 percent. Like reducing the presence of the Fed in the Treasury market thanks to QT, the falling appetite for US debt from foreign central banks means reduced buying presence in the market as well.
Well, what could be worse than the removal of two major buyers – the Fed and foreign central banks – from Treasury auctions?
How about this. At the same time buyers are disappearing, the Treasury has more bonds to peddle. A lot more.
Let me repeat that last part. The Treasury is looking at having to sell trillions of dollars of additional bonds because now the US is looking at trillion-dollar annual deficits each year as far as the eye can see.
More supply. Fewer buyers.
To cut to the chase: There will be buyers for all of those bonds. But only when they pay far higher interest rates.
And higher rates increase the cost of funding government debt. They widen the deficits, which means even more bonds must be peddled. Or taxes must be raised, which is another drag on the productive and tax-paying economy, once again widening the deficit.
Because reducing spending is off the table, everything the government does about the deficit and debt from this point forward perversely widens the deficits.
We have written this piece so far without resorting to a cliché about “a perfect storm.”
But that is exactly what it is.
Last week we wrote that “some Treasury advisors are aware of the incremental, intersecting borrowing demands ahead. But they aren’t trying to figure out how to stop it. They are scratching their heads trying to figure out how to keep the game going.”
Typically, these “solutions” will require that certain individuals, plans, funds and institutions must hold US Treasuries whether they want to or not. That may mean savings accounts, retirement plans, trust accounts, and investment businesses. Of course, nobody has to mandate good investments.
Only those you wouldn’t choose must be mandated.
In times like this, only gold offers shelter from the storm.