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Saturday, February 7, 2009

Bond Markets Made Fun Tolerable

Obama's plan to bail out everything is making the bond markets nervous. The yield on 10-year Treasuries had shot up almost a full percentage point since the end of December. This pushes up the cost of borrowing for everyone, but more importantly for the government and Fannie Mae and Freddie Mac, the US housing giants, just when they'll need to borrow most.

The US is already facing a $1 trillion deficit this year, without even factoring in the cost of the stimulus bill, some $800 billion plus, or the coming bank bailout, likely to be somewhere similar, though these will be stretched out over several years. Still, dude, that's a lot of fucking debt.

One actual bright side of the financial crisis has been that people have piled into safe assets like US Treasuries en masse, driving down the immediate cost of borrowing since investors have merely sought a return of capital, rather than a return on it. This, obviously, will not last.

A painful irony is that the measure of success against the financial crisis is investor's willingness to buy something else other than safe government securities. As they shift out of those, which is what we want, remember, they will inevitably push up government borrowing costs just after we've taken on those gargantuan debt levels. Moreover, any unwinding of global imbalances will require China to save less, meaning fewer purchases of US Treasuries, exacerbating government borrowing costs even further.

As I alluded to earlier, Ben Bernanke has an ace up it's sleeve to deal with this epic problem. Actually, he has an infinite number of aces up his everywhere. The Fed can print money and buy US government securities to drive rates back down, which it seems likely to do shortly. What this means long-term for the dollar and inflation prospects I don't even want to think about. Still, all very exciting.

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