U.S. budget deficit requires more and more Treasuries – wherefore bonds?
To kick things off on the Stockhouse moderated macroeconomics group (see background article here), SH writer/editor and group moderator Robert Arber (known on Stockhouse as SH_Arber) put out a call to the participants to define inflation – what it is, what it means, and how it is manifested in the economy.
The first participants to weigh in were littleguy123 and arnoldj, whose thoughts make up part I of the “Inflation and money supply” series. In part II we’ll hear from frontline_jason and StilesBC, and in part III, self-proclaimed “indeflationist” gabrielgray weighs in. In part IV, members move to a discussion of money supply and inflation measurement tools.
Please add your comments at the bottom of the page, and enjoy!
[Editor’s note: Posts have been edited for punctuation, spelling, grammar and length.]
SH_Arber: Before I knew anything about economics I too believed, as the media tells us, that rising oil prices are a cause of inflation. Then I read Steven Saville, John Hussman and others, and I learned a thing or two about monetarism.
I want to kick this off by coming to grips with a proper definition of inflation - or at least a discussion of what it has meant, what it does mean, what it could mean - after all, an understanding of inflation is key for precious metals investors.
I'd like to hear how members (that's you guys) are taking in all these media reports of Bernanke's "printing press," and what it's got to do with inflation (or inflation expectations). Hussman, for one, argues quite convincingly that there really is no (at least no significant) printing going on - that the Fed's so-called cash infusions aren't really cash infusions at all, just short-term rollover lending.
Of course this ties into which categories of money supply one uses to measure money growth - Saville talked about how important this is, and how especially important it's been lately, in his latest contribution to Stockhouse here.
Just for fun… Webster's American English Dictionary says: Inflation: 2: Continual rise in prices
Investopedia says: Inflation: The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling.
Merriam-Webster says: Inflation: 2: a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services.
I figure that ought to get things moving.
Have at it.
littleguy123: I've now come around to the opinion that “inflation” in the literal form (“true inflation”) is money supply growth minus GDP.
“Price inflation” - which is probably the definition of inflation for the general population, is merely the consequence of real inflation (according to this orthodoxy). Thanks to the lag time for “true inflation” to work its way through the system, and the success of the current campaign of economic propaganda, up to now, “true inflation” has been much higher than “price inflation.”
As the propaganda campaign becomes steadily less successful, and as the natural tendency of the market to seek equilibrium continues, the gap between “true inflation” and “price inflation” should steadily shrink. So for the average person “inflation” is just beginning, while in the broader sense this entire decade has been highly inflationary - and we are just beginning to “reap what we sow.”
arnoldj: There is an 800 lb. gorilla issue dominating the equity markets, commodity markets and bond markets right now and I am in Lee [Adler’s] camp that... and well, to say I am astonished is too understated; the main stream talking heads have ignored it, for the most part.
Treasury bills “crowd out” the rest
We are getting buried, absolutely buried in US Treasuries right now. The weekly treasury offerings from the Fed are at historic levels and they are only going to escalate further. This is why interest rates are now rising as the pressure on bonds is enormous. The cause: The US Federal budget deficit is growing out of control, requiring this supply of treasury issuances. The process is called “crowding out.” In effect, the financing needs of the treasury dept. are crowding out the sources of funds for all other markets.
The Treasury dept. has issued over $200 billion in new supply of Treasuries for May, $68 billion this week alone... this is not just rollovers, this is new supply and the bond auctions the past few days, particularly the 5 year bonds, were characterized as a bust. Indirect bidders largely failed to show up. This is why rates (TNX) took off this week.
Rates rise inverse to prices and bond prices are reflecting supply dwarfing demand, taking the legs out of bond prices so as prices fall, rates rise. The implications are dire and on our doorstep because in a few weeks the Treasury will receive some cash injections from quarterly corporate tax returns, however they have tens of billions in cash management bills maturing and due for payment between June 16th and June 19th (over the weekend).
Again, if they do NOT have sufficient cash to re-pay those CMBs, they have to issue more Treasuries to raise cash and markets (bond and equity) will absolutely tank as rates skyrocket. Lee is calling for a bond market bust before July and I'm in his camp.
Treasury bath and inflation: Three consequences
OK, so what does this mean for inflation. Three things.
First, the source of funds that have been doing much of the heavy lifting buying the Treasuries at these auctions have been foreign central banks, largely OPEC money. China was a huge buyer but has backed off as of late. Brad Setser (Nouriel Roubini's RGE monitor) follows this closely. Russ Winter did a great write up on this as well.
Essentially, foreign central banks print local currency to then purchase the US dollar to buy Treasuries as well as other US debt (notably GSE agency debt of FRE [Freddie Mac and FNM [Fannie Mae]). By doing so they are expanding their own local money supply and this is one of the principle causes of a breakout in inflation in other nations with consequences of rising prices from everything from rice to… well you name it. They are printing money to buy the dollar, funding the ballooning Federal debt in the US.
Sustainable, in my opinion, absolutely not. This is why when you hear analysts and commentators dismiss inflation in the US as a non-issue, referencing a tepid pace of US money supply growth, it's because foreign central banks for the time being have taken over that job from the Fed and are doing it themselves, incurring the inflationary consequences, but local to their own countries.
The second implication [for inflation] is that because the primary dealers that the Treasury dept. issue the debt through have their own balance sheet deterioration, the Fed is facing a situation of buying the unsold debt. The Treasury dept. issues debt to bidders through middlemen, 20 of the largest financial institutions. The indirect bidders are those then who take that debt off the hands of these primary debtors, again, notably foreign central banks.
Well this week for the auctions of 5 year notes, they [indirect bidders] are largely absent. I believe only 20% of the debt was sold on one referenced commentary. This is the issue. THE issue. If foreign central banks back away in a material manner since their coffers are full of US debt already, then who takes their place? Answer, the Federal Reserve. In this scenario the Fed will have to “print” money to buy the Treasuries, in essence, pure monetary inflation via debt monetization. Inflation in its purest form.
This, in my opinion, is what's heading our way all originally sourced by an out of control Federal fiscal budget black hole requiring more and more money to fund it. On a state level California is facing the same situation and a top financial official issued a release today that they are bankrupt by August, out of cash by August unless drastic measures are taken.
So we have, cause: Ballooning federal debt, funded to date by FCBs who are starting to balk and if they walk, there will be two choices left. The Fed to intervene to cover the Treasury dept.’s financing requirements or the Treasury dept. will default on its financing requirements. This game is played over by the end of summer and is the dominant threat we face. Inflation, born abroad to date, could come to the shores of NA within a few months in a major way. Milton Friedman was correct. Inflation is and always has been a monetary phenomenon. Most people only think of inflation as rising prices, no, rising prices are a consequence of monetary inflation.
In addition to this 800 lb. gorilla, add destruction of real estate (think bank balance sheet collateral) and the banks’ forced de-leveraging (think small-mid sized blow-ups) - side note: My god a blind man could see that coming, but those with a vested interest either ignored the issue or deliberately obfuscated matters, well no further. Rising interest rates from Mr. Gorilla are lethal to an already failing real-estate market and will only serve to hasten its downturn. As you guessed, I am a bear as I do not see dependency on foreign central banks recycling petro dollars as sustainable. The moment they fail to show up. Well the money has to come from somewhere and this leads to the third consequence.
The third issue is the de-valuation of the US dollar. If FCBs fail to supply the funds, the Fed will need to or else the Treasury dept. will default on its funding obligations. The Treasury bonds issued by the Treasury dept. are used to raise funds for everything from day-to-day government program spending (education, health, public works, etc.), foreign debt payments, defense spending. Default, especially leading into a presidential election cycle, is simply not an option. The bills have to be paid, so this leads to Ben printing money.
The dollar should in this circumstance head materially lower so anything priced in dollars will head materially higher. No doubt this is what we are witnessing to date. It is no coincidence the dollar started to erode at the time the Fed started taking on to its balance sheet ($400B to date) questionable assets of banks. As it then has to monetize debt, the next wave downward will commence with vigor (think fall-late summer). Pure inflation.
Everything I read, hear, analyze – I put in context of how it impacts the Federal debt and in turn, Treasury financing requirements vs. signs the FCBs are growing weary of covering the bill. Rates have to rise because the requirement for more money is rising and with an expansion of money, inflation must increase. To me, it's that straightforward.
For all referenced figures I point out, I have links and related sources.
Interesting times.
This group discussion was conducted with members of the Stockhouse community.
Next: In part II, “Buyer’s remorse,” frontline_jason and StilesBC work to further define and contextualize the monetary bugaboo known as inflation.
