Relevant and even prescient commentary on news, politics and the economy.

A Billion Here, A Billion There…

This is why Andrew Leonard (h/t Yves Smith) gets paid for blogging and I don’t. He tries to do the impossible: make sense out of Michelle Bachmann’s “economics“:

1) The interest can easily be paid for …

Bachmann is making the argument here that the U.S. can choose to pay its creditors — the various holders of government-issued debt — first, and thus not technically be in default. It’s an open question whether credit rating agencies and bond investors will accept that technicality. China might get paid in full, but millions of Americans would immediate get stiffed. Of course, Bachmann doesn’t mention that choosing such a strategy would require extraordinarily severe and immediate spending cuts — around $4.5 billion a day — in programs such as Social Security, Medicare, defense, unemployment benefits, et cetera. Economists generally agree — the negative economic impacts of such drastic short-term cuts in government spending would almost surely drive the U.S. straight back into recession.

Furthermore, a failure to reach agreement on the debt limit would guarantee bond market jitters, pushing up interest rates and raising the cost at which the U.S. government can borrow funds — and thus end up increasing the deficit.

So what happened today? There was a seven-year Treasury auction:

Today the 7 yr saw a yield of 2.43%, 3 bps above the when issued

The WI is where that same note was trading even as it was being auctioned. Which works out to be about a 19.2 cent reduction per $100 of security.

19.2 cents doesn’t sound like much, but there was almost $30 Billion in securities issued. So that’s $55,642,171
that didn’t get paid to the U.S. Treasury (or $57,433,536 if you’re counting the Open Market Activities).

Even if you want to be generous and assume—it’s crazy optimistic, but let’s be really generous—that half a basis point of that is just a long tail (not entirely unreasonable, but rather generous), there are still $46,376,844 (or $47,869,918) that just got left on the table out of fear of near-term deficit issues.

Not incidentally, that’s $46-57+ million dollars that isn’t available for maneuvering to avoid an official default (as opposed to the practical default that has been in effect for almost two months now). From just one of the nearly 300 auctions that are held every year.

But not raising the debt ceiling won’t mean anything. Michelle Bachmann assures us that just because Social Security/Disability/Medicare etc. payments won’t be made for August 3rd, it’s not a problem.

Sooner or later, we’ll be talking about really money. Right now, it’s just your mother’s livelihood. But at least that money has been saved by those who are investing in seven-year Treasuries. Maybe they’ll loan her some of that savings. Oh, right:

At least we know where they got the money to buy the notes.

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Which country prints more and runs bigger government deficits: Canada or the US?

Even though Europe is on the forefront of global bond news these days, I’d like to revisit the US Treasury market. Specifically, I’ll look at the Canadian-US bond spreads, which tell an interesting tale of Fed purchases and US deficit fears.

First, the Canadian over US government bond spreads for two longer term issues, 10yr and 30yr in chart below, have been falling for some time. Today (Jan. 10, 2011), the 10-yr Canadian Treasury over the 10-yr Treasury spread is around -12 basis points (bps), i.e., the Canadian 10-yr bond is 12 bps lower than the US 10-yr. The 30-yr spread is roughly -86 bps.

The recent divergence of the ‘spread’ between these two spreads presents a bit of a conundrum, since the two have more or less moved in lockstep.

Note: in the chart above, each dotted line represents the period average for the 30 calendar day ( moving average spread of similar color.

The conundrum is this: the 30-yr spread has deviated well below its 2002-2011 average of 8 bps, while the 10-yr spread is sitting roughly at its average, -13 bps. But this is not a conundrum if you consider recent US policy, holding all else equal.

One the one hand, the Federal Reserve is concentrating its bond purchases in the long end of the curve, primarily below the 10-yr maturity. According to the NY Fed, 23% of the $600 bn will be allocated to the 7yr-10yr part of the curve, while just 4% will support the 17yr-30yr end. Therefore, and holding all else equal, the CAN-US spread proxies somewhat the effects of Fed policy in the bond market. The Fed is supporting the 10-yr spread roughly at trend(Section II in chart above), while contemporaneously raising inflation expectations relative to that in Canada.

On the other hand, without Fed support the 30-yr spread is pricing in not only rising inflation expectations but also an increasing US sovereign risk premium relative to that in Canada. This is a similar premium that was attached to Canadian sovereign debt in the early- to mid- 1990s (Section I in the chart above).

Compare the chart below, which illustrates the annual federal deficit in the two countries as a percentage of GDP, to the chart above. Notice how when the red line, (Canadian government deficit) moves aboe the blue line (US government deficit), the average spread drops (Section III in first chart)? That premium is now feeding into the 30-yr spread at an increasing rate (Section II of first chart).

I am in no way suggesting that the US should undergo a similar fiscal austertiy program as that taken in Canada in 1995 (please see Stephen Gordon at Worthwhile Canadian Initiative). What I am demonstrating, though – and rather qualitatively, I might add – is that absent active Fed purchases in the back end of the curve, there is a risk premium emerging in the US bond market relative to that of at least one country with markedly lower government deficits, all else equal, of course.

Rebecca Wilder

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Is it true that foreigners finance American debt?

This is the question raised by Brenda Rosser in a couple of posts at Econospeak Is it true? To which Barkley Rosser (no relation to Brenda and in fact living on the opposite side of the world-it really is an odd and small blogosphere sometimes) replies in part as follows:

The Chinese central bank has been buying lots of US Treasuries to help keep the dollar up and the yuan/rmb down, so that US citizens will continue to buy Chinese exports. It is that simple.

With apologies to Prof. Rosser (a huge ally in the Social Security debate) I suggest that rarely is anything related to such matters ‘that simple’.

Not being an expert here I fall back on the only tools I really have. Which is to say official government data sets and a calculater. In this case I am going to start with this table which shows holdings of US Treasuries by month from Sept 2007 to Set 2008 MAJOR FOREIGN HOLDERS OF TREASURY SECURITIES. And after a little examination of the numbers it would appear that the answer to Brenda’s question is not in fact ‘Well, duh’ but instead ‘Well lets see if we can make sense of the actual numbers’.

Because as usual everything is simple if you ignore the complexities.

The first thing to note is that while China was indeed the largest foreign single holder of Treasuries in Sept 2008 that is actually something new, for every other month shown Japan actually held more. Nor do the numbers show that China was buying aggressively, in four of the months in the table their net holdings actually dropped. If we would have been having this discussion in July (with data through June) the answer to Brenda’s question, at least in relation to China would have been ‘Well not really’ with Chinese holdings increasing on average $4 bn a month over a nine month period. (Social Security’s cash surplus loaned to Treasury over this period would have been about double that and its accumulated balance right at 4X that of China).

Still obviously China is the biggest single current player, after all in the three months from June to September they added $81 billion to their portfolio. On the other hand over that same period ‘Carib Banking Centers’ added $63 billion to theirs, while the UK (which includes tax sheltering Channel Islands) added $58 bn. Now given banking secrecy laws in these countries it is impossible to know how much of these asset purchases were on behalf of Americans or American based MNCs, but clearly it is a number well north of zero.

If we proceed to look at these numbers in percentage terms China is essentially holding steady, maintaining right at 20% of all such foreign holdings. That is as the U.S. stepped up borrowing they stepped up lending but only in proportion to the new debt being issued. Nor were they getting backstopped by the rest of East Asia: Japan, Hong Kong, Taiwan, Thailand all reduced their holdings modestly, while Korea and Singapore held fairly steady over this period.

If we back up and look at who dramatially stepped up over the course of the year we get some unexpected suspects, particularly is we look at the percentage increases: UK $120 bn to $338 bn, Carib Banking $99 bn to $185 bn, Oil Exporters $137 bn to $182 bn (no surprise there), but then we have Luxembourg going from $58 bn to $91 bn, Russia from $32 bn to $70 bn, and Norway from $22 bn to $52 bn. Now some of this can be explained by oil prices but by no means all, I don’t recall that either the Caribbean or Luxembourg as being particularly dotted with oil wells. Nor would they seem to be huge net exporters to the U.S.

It is easy to get mesmerized by the sheer size of China and the fact that just about everything sold at WalMart (and most everywhere else) comes from East or Southeast Asia. But those who would explain everything by pointing to current trade accounts or the Chinese desire to prop up the yuan/rmbi have some explaining to do. Because there is a sea of money flowing to Treasuries (totalling up to more than 80% of the new demand) from outside Asia. And the question of how much of that money ultimately has American fingerprints on it is a good one, after all we know there are huge tax avoidance games going on, and some of that cash will inevitably end up in foreign held Treasuries.
While I am at it can we get some overall perspective on the debt? If we visit the Treasury’s Debt to the Penny we can see the following totals:
Debt held by the Public $6.4 trillion
Intragovernment holdings $4.2 trillion
Total $10.6 trillion Okay that is a lot of change. On the other hand it includes some $2.3 trillion in Social Security asset/liabilities/Special Treasuries/’phony IOUs’ (pick one) that will not start being redeemed until 2023. In some sense our ‘real debt’ (that which could be dumped on the market tomorrow) is limited to that $6.4 trillion.

Still a lot of change. But to keep an apples to apples approach what was that number on Sept 30th? $5.8 trillion (my Hank P has been busy). How much of that was held by (ostensibly) foreign holders? $2.86 trillion. By China? $585 billion. Or 10% of all debt then held by the public, 5.5% of all total debt.

Frankly the notion widely promulgated over the last few years that the U.S. was hopelessly exposed to some decision by the CCB to dump Treasuries always seemed overblown. And the ability of Treasury to raise even more than that over a two month period ($5.8 trillion to $6.4 trillion since Sept 30th) seems to have proved the point. I am not so naive as to believe that the world will continue to effectively lend money to the U.S. for returns that are effectively negative for unlimited periods of time. But I do suggest that to reduce everything to the Current Trade balance with China and the willingness of the PRC to prop up exports by buying dollars is just that: reductionism that does in fact ignore the complexities, in part by not putting the numbers in context.

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