In March, the United Kingdom experienced something that hadn’t happened in nearly 15 years: a bond auction failed. Failures like this are becoming more common in the developed world. So far this year debt auctions have failed not only in the U.K., but also in Germany and Latvia. These failures have sent shocks through the international monetary system – weakening banks, currencies, and governments. Investors have taken them as signs that a government might be following an unsustainable spending path, or that the nation’s currency was risky – and might be headed for inflation.
Could it happen here?
When the United Kingdom experienced its failed auction, analysts pointed to a critical problem surrounding the debt issue: investors were scared off by uncertainty about the strength of the Bank of England’s commitment to quantitative easing. That’s the term given to moves by the central bank to purchase bonds and get credit moving. So far, there has been no concern that the U.S. Federal Reserve would give up on quantitative easing anytime soon. That’s one reason the U.S.has not experienced a failed auction yet.
Despite the relative confidence that Federal Reserve Chairman Ben Bernanke will continue to pursue a policy of quantitative easing, the U.S. Treasury has already had one ‘awful’ auction this year. In May, investors concerned by excessive spending and high deficits pushed yields higher. Absent confidence that the Federal Reserve was ready with a blank check, the auction might have turned out worse.
Could things change in the near future?
At a recent appearance before the House Budget Committee, Chairman Bernanke warned that ‘maintaining the confidence of the financial markets requires that we, as a nation, start planning now for the restoration of fiscal balance.’ He added said that both economic growth and stability are at risk unless we ‘demonstrate a strong commitment to fiscal sustainability in the longer term.’ Lastly, he asserted that the Federal Reserve ‘will not monetize the debt’ – calling for spending cuts or tax increases.
As businessman and investor Francis Cianfrocca recently observed:
Bernanke is engaged in an effort to stimulate an economic recovery by using monetary tools to reduce the level of medium and long-term interest rates (”quantitative easing”). The Treasury is trying to add to the effort by using fiscal tools (Keynesian stimulus). What everyone hopes will happen is that the economy will pick up and start generating its own momentum, so that by the time interest rates start ticking up by themselves, we’ll be able to lay off both the quantitative easing and the stimulus spending.
The danger, however, is that expectations for economic recovery will cause investor dollars to flow away from Treasury debt and dollar-denominated investments altogether, before the job has been done. As medium and long-term interest rates rise, Bernanke finds himself under considerable pressure to expand the quantitative easing program, which he’s very reluctant to do because of the danger of runaway inflation.
According to Cianfrocca then, the test will be whether economic growth will allow the federal government can lay off its stimulus spending, and the Federal Reserve to pull back from quantitative easing. The problem is that at least with regard to federal spending, Washington is projecting both a return to economic growth, and enormous Keynesian deficits.
According to the Committee for a Responsible Federal Budget, the federal ‘structural deficit’ – the basic gap between spending and taxes – is about $500 billion annually right now. High discretionary spending – such as that contained in the Obama ‘stimulus’ package – may push that number higher. It could also be driven higher by costly initiatives like health care reform, cap-and-trade, or others. Without knowing precisely how much Congress and the President will spend, it’s impossible to project just how big the debt will grow. However, the Congressional Budget Office’s current estimate is that it will climb from about 42 percent of Gross Domestic Product in 2008 to 82 percent by 2019. And right now the drive in Washington is not only against stanching the flow of red ink; it’s to drive the deficit higher.
The Federal Reserve cannot indefinitely continue the easy credit policy that enables such deficit spending. At some point the unwillingness of the Fed to purchase debt, or the higher cost of debt financing as investors turn to other properties, will make larger deficits unfeasible. It could also be the point at which a failed debt auction becomes a possibility. The shock to the U.S. economy and the global economy would be far greater than those associated with similar failures in smaller economies.
And not to put too fine a point on it, but as Cianfrocca makes clear, Americans are caught between Scylla and Charybdis. One of the factors that makes debt servicing more expensive – and thereby makes it harder to run large deficits – is strong private sector growth. Treasury securities are a lot harder to sell if there are significant returns to be had somewhere in the world in the private sector. Government debt is easier to carry if the world is caught in a slow-growth trap, where there’s nothing better to buy. So if you’ve ever wondered whether big government advocates actually want slower private sector growth – there’s probably a good reason.
Brian Faughnan's Bio
Brian Faughnan is a contributor to RedState.com and the Weekly Standard blog. He has written columns for the D.C. Examiner, and has provided political commentary on National Public Radio, XM, SkyNews, and other media outlets. Mr. Faughnan is a 10-year veteran of Capitol Hill, and has worked as a lobbyist and a consultant. He resides in Virginia.
Posted
06-19-2009 8:57 AM
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