Statistics from the federal government document how the Federal Reserve over the course of 2009 bought some 80 percent of the $1.5 trillion borrowed by the U.S. Treasury – making the federal government like the family that uses Visa to pay down a monthly MasterCard bill.
Remarkable as that may seem, data make clear the Obama administration has been managing trillion dollar federal budget deficits by selling financial instruments to the Fed.
Even to sophisticated investment analysts, using the Fed to buy Treasury debt is the equivalent of simply printing money to pay for government-funded programs an increasingly bankrupt United States can no longer afford.
While the Federal Reserve’s massive purchases of Treasury bonds and government agency debt, including debt issued by the government-sponsored mortgage giants Fannie Mae and Freddie Mac, has keep interest rates low, the Federal Reserve Open Market Committee in its Dec. 15-16, 2009, meeting strongly suggested the program to buy debt issued by U.S. Treasury, government-sponsored agency debt and mortgage-backed securities will come to a close at some point.
And with the Chinese revealing a diminishing appetite to buy U.S. government debt, the Treasury is facing a crisis regarding how to sell possibly $2 trillion in new debt to finance the 2010 Obama administration federal budget deficit.
The likely results of the crisis – rising interest rates and hyper-inflation – could include a burst stock market bubble and a deepened real estate foreclosure crisis and also could force average Americans to face higher prices as the dollar continues to lose value against stronger currencies, such as the euro and possibly the yen.
How will Obama continue to sell trillions of dollars of debt?
The amount of Treasury-issued debt has spiked in the first year of the Obama administration and is likely to continue at elevated levels given the $9 trillion in federal budget deficits President Obama has projected over the next 10 years.
The fiscal 2009 federal budget deficit totaled nearly 12 percent of gross domestic product and required more than $1.5 trillion of newly issued Treasury debt to finance it, according to Bill Gross, an investment analyst at the giant bond dealer PIMCO.
Foreign investors including the Chinese bought somewhat under 20 percent of the $1.5 trillion of Treasury debt the Obama administration needed to sell in order to finance the $1.84 trillion federal budget deficit in fiscal year 2009.
In other words, in fiscal year 2009, the Federal Reserve purchased approximately 80 percent of the Treasury debt issued to finance the Obama administration budget deficit.
The Federal Reserve has also become a buyer of last resort for government agency debt.
When the Federal Reserve discontinues its program of buying U.S. Treasury and government agency debt, interest rates will almost certainly have to rise in order to attract buyers.
Warnings from China
In 2009, China led foreign investors in selling mortgage securities issued by government-sponsored entities Fannie Mae and Freddie Mac, according to an analysis published in the Wall Street Journal last July.
China has warned Richard Fisher, the president of the Dallas Federal Reserve, that the Obama administration is “monetizing” the U.S. debt by allowing the Federal Reserve to purchase Treasury debt.
With little fanfare, China’s foreign-exchange reserves have grown to $2.27 trillion at the end of September, a dramatic 700 percent increase in the last 5 years.
This comes at a time when China is increasingly concerned that inevitable dollar devaluation makes holding dollar assets a risky foreign-exchange reserve strategy.
In 2009, China, the largest foreign holder of U.S. Treasury debt, reduced its holding of U.S. Treasury bonds out of a concern over the safety of U.S.-dollar-linked assets.
According to the U.S. Treasury, China remains the largest foreign holder of U.S. Treasury debt, amounting to $798.9 billion in October 2009, with Japan second on the list at $746.5 billion.
One day after Chinese Prime Minister Wen Jiabao snubbed President Obama at the U.N.’s Copenhagen Climate Summit in December, the Chinese warned the United States that China’s ability to continue buying U.S. Treasury debt was limited.
Zhu Min, the deputy governor of the People’s Republic of China, told the Shanghai Daily that it is getting harder for the People’s Bank of China to buy U.S. Treasuries because the shrinking U.S. currency account is reducing the supply of U.S. dollar foreign exchange reserves overseas.
This was dire news for the Obama administration that in 2010 – and for the foreseeable future – will be dependent on China to buy U.S. Treasury debt to meet the demands of the proposed trillion dollar budget deficits.
The Shanghai Daily reported that Zhu told an academic audience that it was inevitable the value of the dollar would fall given the increasing reliance of the Obama administration on issuing U.S. Treasury debt to finance deficit spending.
“The United States cannot force foreign governments to increase their holdings of Treasuries,” Zhu said. “Double the holdings? It is definitely impossible.”
Zhu’s warning was clear.
“The world does not have so much money to buy more U.S. Treasuries,” he said.
What China’s warnings portend is that the Obama administration’s determination to expand the U.S. social welfare state will necessarily meet a limit when foreign nations lack the U.S. dollar foreign exchange reserves needed to purchase increasing amounts of U.S. Treasury debt.
Zhu’s comments were a warning to the Obama administration that China does not approve of the large and continuing trillion dollar deficits the U.S. is projecting into the future, or of the way the Obama administration has chosen to finance those deficits.