The Kindness of Strangers

With a deficit of $1.2 trillion this year, and President-elect Obama making it very clear that such deficits will continue into the next couple of years, there is one huge fly in the ointment – someone has to buy that debt. What is clear, unless interest rates go up considerably, buyers are likely to leave Treasuries behind and place their investment money elsewhere. If interest rates are forced to rise in this recession, the credit freeze could look a lot like walk in Antarctica.

What’s worse, countries like China – which has been a huge buyer of short-term Treasuries – have their own set of domestic problems and are deploying that money to solve local issues. China has its $600 billion stimulus package to pay for. That story seems to be repeated all over the world.

The January 8th New York Times: “In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries…” But all that is changing. “‘All the key drivers of China’s Treasury purchases are disappearing — there’s a waning appetite for dollars and a waning appetite for Treasuries, and that complicates the outlook for interest rates,’ said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland.”

Just as bank regulators are forcing banks to release loans into the marketplace – there are purportedly $1 trillion sitting idle in banks right now – the government could be placed in the difficult position of having to pay much more interest (i.e., raise the interest rates to attract buyers for its Treasury notes) to incur the massive deficits required to restart the U.S. economy.

Higher interest rates would slam housing values (who’s going to buy the overstock of inventory, when the loan rates are high?) and slap the business credit market in the face before it even started, just as unemployment rates are flying upwards. We could have a severe recession (or as I have called it, a “managed depression”) combined with inflation (“stagflation”) as the currency falls with the inability to place our national debt.

Treacherous shoals are everywhere. And the economic ocean storms are roiling. We would indeed be “lucky” if we bottomed out in the second or third quarter of this year. I guess that redefines the word, “lucky.”

I’m Peter Dekom, and I approve this message.