Due to an absence of foreign buyers the US Federal Reserve has been forced to step in and buy 61% of the new debt issued by the US Treasury, and in doing so the Fed is propping up the US economy and financial markets.
Writing in the Wall Street Journal, Lawrence Goodman, a former Treasury official and current president of the Center for Financial Stability, states that “Last year the Fed purchased a stunning 61 percent of the total net Treasury issuance, up from negligible amounts prior to the 2008 financial crisis.”
He goes on to say, “This not only creates the false appearance of limitless demand for U.S. debt but also blunts any sense of urgency to reduce supersized budget deficits.”
As foreign creditors and other investors have backed away from US government debt instruments the Fed has been forced to step in as buyer of last resort. This intervention in the government debt market gives the illusion that the demand for US Treasury bonds is higher than it actually is. It also helps keep interest rates and therefore debt refinancing costs at a minimum.
The U.S. central bank is therefore propping up the US economy and financial markets.
In 2009, foreign investors such as Japan and China purchased US debt amounting to 6% of GDP. Today however, they buy just 0.9%.
Mr Goodman continues, “The Fed is in effect subsidizing U.S. government spending and borrowing via expansion of its balance sheet and massive purchases of Treasury bonds. This keeps Treasury interest rates abnormally low, camouflaging the true size of the budget deficit…Similarly, the Fed is providing preferential credit to the U.S. government and covering a rapidly widening gap between Treasury’s need to borrow and a more limited willingness among market participants to supply the Treasury with credit.”
Net issuance of Treasury securities is now averaging 8.6% of GDP per annum, more than double levels before the crisis, and the US government is growing increasingly more dependent on borrowing to finance itself. Not only do I expect this trend to continue, I expect it to spread from the US to other G20 countries.
Ultimately these nations have a choice: Print the money to meet their obligations and risk destroying their currencies, or enter a 1930’s style depression. Personally I believe they will choose the former.