Monetization Nation

First off, sorry for the delay in postings-- I'm having electric problems in the house.. specifically the room where I have my wireless router. A week and an expensive (and long) extension cord later and-- I'm back !!


For the most part, thanks to Bens printing press and the US Government spending three dollars for every two it takes in taxes, the economy has begun to see signs of life. The U6 unemployment rate has dropped below 16% for the first time in a long time. While there will undoubtedly be a revision in the numbers, the trend is down-- at least in the short term. But even now there are ominous signs-- real wages for Americans continue to decline, as do home prices. If QE2 ends in June as I expect, job creation will come to a halt shortly thereafter as the Fed's rocket fuel is withdrawn. 


Speaking of these things.. Ben's printing presses and US Government deficits.. lets get down to some figures here. Since the start of QE2 last November, the US Government has issued $890 billion in bonds. Of these, $291 billion was for debt maturity paydowns of bonds that matured. This leaves us a net of $589 billion in new issuance since November. Since it's illegal for the Fed to outrightly go to the auction and purchase debt itself, what it does is it goes into the secondary markets behind the auctions and does it's purchasing. Since November, the Fed has used these secondary markets to purchase bonds using a tool that's commonly called POMO (permanent open market operations). Since November, the Fed has used POMO to purchase $491 billion in bonds, with much of these bonds being the ones recently auctioned off. In short, the Fed is (re)purchasing approximately 83% of all bonds issued by the US Government. What this says is that the usual purchasers of US Debt-- domestic investment funds and foreign investment funds, have come up with approximately 17% of the needs to fund the US Gov't, with Ben's printing presses doing the rest. Simply put, we're printing "funny money" to fund the US Government's operations. 


QE2 is due to end in June, and I believe it will end-- but only for a time. For the US Government to legitimately fund the 83% of debt needs that the Fed is currently doing, the interest rates offered will absolutely have to go up if they have even the faintest hope of remaining solvent. I look for the 30 year US Bond to go north of 5% and the 10 year to reach 4%. Still pretty good in actuality. But this money will have to come from somewhere, and there is a chance that some of it will come from the stock markets (I look for the NYSE to go back towards 10K). If there is a crisis abroad, foreigners will also pile into US Bonds. Inflation has begun to roar over the last six months-- food prices were one of the primary reasons (along with despotism, hopelessness and disenfranchisement) that started the current crisis in the Middle East. Prices will continue to rise here in the US as well; take a look at the price of a loaf of bread these days as well as the price of gas, which I think will near $4.00/gal this year. Diesel is already there. If we continued down this same path, gas would reach $5.00/gal sometime next year. For a sitting President hoping to be reelected, this is not an option. 


But lets ask ourselves this-- how long can any government spend three dollars for every two it takes in and then print the difference ? The US is caught in a numbers vice grip-- print and suffer inflation, or somehow (between a combination of spending cuts and higher interest rates to attract legitimate buyers) fund ourselves legitimately. My guess-- when the US Ten Year Bond approaches 4.5%, Bernanke will crank up the presses again. If there is a crisis abroad, it might actually be some time before this comes to pass. But if the markets and world economy continue to expand and recover, we'll see it before 2011 passes us by. 


A large part of the problem resides in Congress-- Republicans absolutely refuse to go along with any tax hikes, and Democrats absolutely refuse to allow any cuts to social programs. The path of least resistance you ask ? Borrow like there's no tomorrow. Some of this lies with us, the voter as well-- if given the choice between a candidate who says "Listen folks-- we're flat broke and we're going to have to pull the troops out of Afghanistan, cut Medicare and raise taxes" or Candidate B who says "This is a tough time, but none of these drastic measures are needed-- there are better options" the electorate will vote overwhelmingly for Candidate B every time. We as a people refuse to willingly face the Day of Reckoning. But make no mistake-- it's coming. Ireland was a very low tax, high growth nation throughout most of the 2000's-- and today they've been scuttled out back to the IMF's outhouse and have an unemployment rate north of 15% thanks in large part of their banks loaning too much to too many (sound familiar ?). The only difference between the US and Ireland is time.