Brother, Can You Spare a Billion?October 22, 2012 Posted by: Joe Morgan, CFA
It's a gas
Grab that cash
With both hands
And make a stash
Last week, for the first time in seven years, England had agovernment bond auction fail. This effectively means the Bank ofEngland offered up some newly minted bonds for sale and investorssaid, "(Burp!), I'm full. Thank you anyway."
With all the talk about what the U.S. would do should foreigninvestors shy away from Treasuries, we have an example right acrossthe pond. The answer: finger-pointing and government predictionsthat the next auction will be well-received.
Here in the U.S., a failure would not occur because there are toomany "back up" buyers available. First of all, the 19 prime dealersare all beholden to the Treasury who has made it very clear overthe years that they should buy a certain amount of Treasuries ateach auction regardless of client interest. If these dealers refuseto lend to the Treasury, they will surely find themselves out offuture auctions and perhaps under some scrutiny by other governmentagencies. This is the reverse model of the mafia loan shark: Youmust lend to us or else!
Even if that fails, the Fed will surely step in. Effectively, whenthe Fed buys Treasuries they are printing money. To see this, onemust realize the Treasury is selling bonds in order to finance somesort of government spending. Well, if the government spends andthen borrows from itself to fund that spending, that is the same ascranking up the printing press.
If, however, the primary dealers and perhaps other banks buy up thesupply for their own accounts, it will lead to inflation as well.To see this, one must realize these banks are low on capital. Anyincrease in their balance sheet - even with so-called"zero-risk-weighted assets" such as Treasuries - decreasesimportant capital ratios. This leads banks to turn back to thegovernment for further capital injections, which then must befunded by issuing more Treasuries.
Over the last year, the money supply - defined as currency, savingsaccounts, small time deposits and retail money funds (AKA M2) - hasgrown 9.8 percent and is on schedule to...Read More