By Bud Conrad, Chief Economist
The basic imbalance driving our economy is the government deficit, which spun out of control as a result of the Credit Crisis of 2008/9. But the sequester, improving tax base, lower interest rate, and elimination of stimulus spending have caused the big government deficit, while still extreme, to drop to half its previously nosebleed levels.
Even so, the deficits remain well out of proportion for a sustainable future. Projections for future government expenditures, including those related to the masses of retiring baby boomers, are on track to increase exponentially. Especially given that the deficits are actually much worse than generally discussed. Honest accounting would include the growing liabilities for retirees in the current accruals, resulting in deficits running closer to $5 trillion per year.
Foreigners recycling their trade surpluses have been an important source of purchases for US government debt. As you can see from the chart of long-term securities purchases by foreigners, that buying collapsed during the crisis. And, interestingly, it has recently fallen sharply again.
Offsetting the reduction in purchases of US debt by foreigners, the Fed has stepped in with multiple quantitative easings (QE), buying government securities itself in order to add liquidity and drive interest rates down. The shift into an accommodative policy is easy to see in the big picture of the holdings of Treasuries at the Fed:
Simply, the loss of foreign enthusiasm for US government debt would normally be a red flag for our economy. This time around, the slack is being papered over by the Fed, which is creating money out of thin air in order to buy what is, in essence, most of the new debt being issued by the federal government. By filling the gap left by exiting foreigners, the Fed has been able to sustain low interest rates—for the time being.
As the American public doesn't save much, and because foreigners are stepping away from US government debt, the Fed is left as the buyer of last resort and will have to keep up its QE.
Among a number of problems, the money creation required for the Fed to serve as the government's lender of last resort can be very inflationary once it ultimately bleeds into the economy. For now, most of the new money has been bottled up on the balance sheet of the Fed. With low rates, that is manageable. But if rates rise, as they eventually must in the face of rising inflation and a loss in confidence in the dollar, the interest the Fed pays on deposits rises as well, putting the viability of the institution at risk.
In addition, as rising rates increase the cost of servicing the government's many debts, federal deficits will also rise. And that has the very real potential to create the equivalent of an economic death cycle as foreigners, and pretty much anyone other than the Fed, rush to the exits on US government paper, causing interest rates to rise further.
While it is impossible to say with any certainty when the US government bond bubble, the largest in history, will burst, the recent up-moves in interest rates should serve as a clear warning shot. From the charts, it looks like the foreigners have taken notice.
For those of you interested in learning more about the coming end to the bond bubble, the latest edition of The Casey Report contains Bud Conrad's up-to-date report and in-depth analysis on inflation, deficits and interest rates. Your subscription comes with a 100% money-back guarantee… so you have nothing to lose by giving it a try. Click here for details.
I agree 100% The brainless Fed, in a simian effort to bypass the basic laws of economics and a short corrective depression, has created a long-term phony economic monster with smoke and mirrors such as the “Stocks Rally” to disguise what really is happening. This monster must be fed trillions of $ to keep it from collapsing. As the above article points out, so far The Fed has been able to get away with it by leaning on the rest of the world with bond sales and the Reserve Currency scheme. However, that is all coming to an end and the time to pay the piper is nearing. When this whole charade blows up, the explosion is going to rival The Big Bang on an earthly scale!
(P.S. Do you have gold and silver?)
We are still the best dressed pig in the pen. Our banker, China, is undergoing a credit contraction, however. Bonds may go back up a bit this week as the market tops out at 1706-13 before an intermediate term decline as China's cold may spread to others, or even turn into a mild case of pneumonia. But, long term we all have to hope our Banker improves as the most intelligent group of people on the planet thrives with its stolen intellectual property, for without that, Dependency Nation will continue its decent into the quicksand of Precious Mendacious Baraximus's transformative USSA after a last gasp, but tremendous rally into the 1790 area on the FED's free money.
The recent up-moves in rates were simply a result of taper testing. It's the only way to gauge the amount of new bond-buying the market will support or need. Or maybe a test of the Bernanke-Yellen/Summers transition?
If official figures show that the deficit has been cut in half, then the figures are bogus. The economy is not better, there is no "recovery". there cannot be when 40% of the new jobs are part-time in the service sector, while manufacturing continues to decline. Without a robust increase in good paying jobs (you can't have this without a revival in industrial production) that allow consumers to spend, then we are and remain dead in the water. The figures have been rigged to make it appear that there is a recovery, they are translating inflation into growth to disguise a continual and relentless decline. The US has been de-industrialized by offshoring, we are well on our way to becoming a non-developed nation. Our currency only remains as the global reserve because of unlimited corruption combined with military threats.
This cannot work forever, it is a house of cards; once the petrodollar is history, so is the dollar reserve status. Then the sh*t hits the fan big-time.