The financial services industry is full cry in its demands for taxpayers to save its hide. From Bloomberg:
Bill Gross, co-chief investment officer of Pacific Investment Management Co., said the U.S. may slump into a “mini depression” unless policy makers spend trillions of dollars to spur growth.
“This economy needs support from the government, a check from the government in the trillions,….There is a potential catastrophe if the U.S. government continues to focus on billions of dollars.”…
Pimco won a Federal Reserve contract in December as one of the four managers of a $500 billion program to purchase mortgage-backed securities. The company was also one of the managers selected to run the Commercial Paper Funding Facility in October.
The Fed will have to step in and buy Treasuries, Gross said, to keep long-term interest rates low as the U.S. increases its debt sales to finance a growing budget deficit and stimulus programs…
Speculation has risen that China, which holds $681.9 billion of Treasuries as the single largest investor in U.S. debt, may stop or slow the purchases of U.S. debt as its own economic growth slows…
Yves here. Brad Setser, who follows international funds flows generally and China in particular, sees no such risk on this front, at least this year. Indeed, some think China may pick up its purchase to lower the RMB, although that runs the considerable risk of retaliation from the US and other advanced economies.
The real risk is the supply side, not the demand side, and higher spending merely makes the funding gap greater, albeit with a bit of a lag.
Recognizing that, China is moving to shorter maturity Treasuries, seeking to reduce its exposure to inflation, which erodes the value of longer dated bonds far more than short ones.Back to the article:
“To the extent that the Chinese and others do not have the necessary funds, someone has to buy them,” Gross said. “It is incumbent upon the Fed to step in. If they do, that will be a significant day in the bond market and the credit markets.
Yves here. He’s right on the latter point, although that’s like saying a heart attack is a significant event. Buying Treasuries is a desperate move by the Fed that will work for a while, but I cannot seeing it do more than stave off the inevitåble for a little while. How will the markets react to the specter of a burgeoning Treasury balance sheet, with its purchases in a loss position on any kind of “real” mark to market basis (an unmanipulated market price on the bonds would be considerably lower). The 30 year bond has fallen from a peak of 142 to its current level. That’s a nearly 20% loss in less than a quarter.
And how will the markets react with the realization that the Fed is insolvent? This isn’t lunatic fringe thinking; Willem Buiter (a respected and generally left-leaning economist), who has advocated that the US engage in less rather than more deficit spending, has discussed the risk to central bank solvency of absorbtion of private sector losses. In a recent, more urgent, post, he contends the US is on its way to default (either explicit, or far more likely, implicit, via inflation) unless in contains its level of spending:
There will, before long (my best guess is between 2 and 5 years from now) be a global dumping of US dollar assets, including US government assets. Old habits die hard. The US dollar and US Treasury Bills and Bonds are still viewed as a safe haven by many. But learning takes place. The notion that the US Federal government will be able to generate the primary surpluses required to service its debt without selling much of it to the Fed on a permanent basis, or that the nation as a whole will be able to generate the primary surpluses to service the negative net foreign investment position without the benefit of ‘dark matter’ or ‘American alpha’ is not credible….
The US Federal government has taken on massive additional contingent liabilities through its bail out/underwriting of the US financial system (and possibly other bits of the US economic system that are too politically connected to fail). Together will the foreseeable increase in actual Federal government liabilities because of vastly increased future Federal deficits, this implies the need for a future private to public sector resource transfer that is most unlikely to be politically feasible without recourse to inflation. The only alternative is default on the Federal debt. There is little doubt, in my view, that the Federal authorities will choose the inflation and currency depreciation route over the default route.
If I can figure this out, so can anyone in the US or abroad who follows recent economic developments. The dawning of the realisation will lead to the dumping of the assets….
Now my German buddies remind me that in the German hyperinflation, government bonds were the last asset type to tank. Even in 1923, they traded at a yield of 6% before collapsing. So even in the face of rampant actual or expected inflation, the authorities can hold seemingly inexorable forces at bay longer than one might expect.
And Bloomberg gives us the real reason behind Gross’appeal:
Gross, 64, increased his holdings of U.S. government debt, a category that includes agency securities, in December for the first time in a year, according to the company’s Web site.
Pimco is structurally long bonds, so declining interest rates are in his favor. But more immediately, unless he went long very short maturities, he is probably sitting on losses on his December bet, and without Fed intervention soon, he is unlikely to get whole on those purchases.