-- Posted Thursday, 23 April 2009 | | Source: GoldSeek.com
The Daily Gold Report by Peter A. Grant
On Wednesday the UK's Debt Management Office (DMO) announced they would be issuing a whopping £220 bln ($319 bln) in gilts this fiscal year. That's a 50% increase from the £146.4 billion borrowed in the fiscal year ended 31-Mar, and well above the £180 bln the market was expecting.
Not surprisingly, gilt futures tumbled on the news, driving yields higher. In addition, the British pound retraced all of the previous day's gains -- and then some -- falling to new 3-week lows.
Of course, higher interest rates are the last thing the UK economy needs right now. After all, the BoE has gone to a lot of trouble, slashing its repo rate from 5.0% to 0.5% over the past year and implemented quantitative easing in an effort to keep rates low. Rising interest rates after all that might be construed as a policy failure.
You may recall that it was just last month that the DMO experienced their first failed gilt auction in 14-years -- where demand fell well short of the supply of gilts offered. Given the huge increase in gilt issuance, one might expect that the 25-Mar auction won't be the DMO's last uncovered auction.
Here on our side of the pond, we're faced with the same predicament: The need to issue massive amounts of new debt into a market already awash with debt. At the same time, the historic buyers of our debt (China and Japan specifically), faced with their own domestic economic concerns and understandable worries about the huge amounts of dollar denominated instruments already on their books, have hinted that they may be looking to scale back purchases.
The Congressional Budget Office has projected a $1.85 trillion budget deficit in 2009 and that may prove to be a rather conservative estimate. While the government is pumping trillions of dollars into the economy in the form of fiscal stimulus and various bailouts, more and more American workers are finding themselves without jobs.
As the unemployment rate has risen, tax receipts have plummeted. At the same time, government spending on safety-net programs -- like unemployment insurance, food stamps and various Health and Human Services plans -- has soared.
It is likely that Treasury will need to issue more than $2 trillion in new bills, notes and bonds in FY2009 to cover the shortfall. So far, interest in US Treasury auctions remains pretty good as a result of the safe-haven appeal of US debt in an environment of global economic uncertainty.
A fair amount of that faith may be misplaced. I think the Chinese and Japanese realize that reduced participation in US auctions puts their existing reserve portfolios in substantial jeopardy.
Nonetheless, one has to wonder; at what point does supply completely overwhelm demand?
If -- or perhaps it's really a question of when -- that happens, Treasury, the Fed and the Obama administration are faced with a rather interesting set of choices:
Do you slash spending, thereby reducing the amount of debt issuance necessary to reduce supply? Or, do you raise interest rates to increase investor demand for US debt?
Either choice presents substantial risks to growth and recovery for an economy already on the ropes. Further blows to the economy will likely result in more job losses, which in turn will lead to an increased need for debt issuance for all the reasons already outlined. It is doubtful that there is sufficient political will in Washington to take either path.
The third alternative, which may unfortunately be the most politically expedient option, is to artificially increase demand for our debt. In other words, ramp up the quantitative easing operations that are already underway. Print more dollars and use them to buy more of our own debt.
This of course puts us ever deeper in debt. The secret to getting out of a hole is to first stop digging. That simple fact seems to be lost on those who work inside the beltway.
The Fed has already spent about $60 bln of the $300 bln they plan to spend on buying government securities over a six month period that began in March. That is just a small percentage of the $1.2 trillion the Fed has committed to broader quantitative easing efforts.
This of course puts us ever deeper in debt. The secret to getting out of a hole is to first stop digging. This simple fact seems to be lost on those who work inside the beltway.
Almost as if on queue the yield on 10-year notes has pushed back toward 3.0%, the highest level since the Fed announced their buyback plans. After all the extraordinary measures taken in the past year, the 10-year yield is less than 70bp lower and the national average for a 30-year mortgage hovers just below 5.0%.
If this goes much further a rational mind might come to the conclusion that present policy has failed. However, the more likely conclusion in Washington may be that if $300 bln in government buyback of Treasuries isn't enough to lower rates, it must take $600 bln...or more.
Such efforts may serve to buy more time, but the piper is going to still have to be paid at some point -- and the tab is growing rapidly. As the father of two young boys, I worry that they are going to be saddled with a smothering federal debt load as a result of today's fiscal and monetary folly.
The heightened dollar risk may also finally break the will of our creditors, prompting them to pullback from buying Treasuries and seek to further diversify their reserve holdings. That will put further pressure on the greenback, which will then increase the already loud calls for a new global reserve currency.
A falling dollar will ultimately lead to inflation.
A vicious circle indeed.
No matter how this all eventually shakes out, gold will continue to serve as a critical hedge and important diversification. Gold remains below the $900 level, providing an opportunity to begin building your position in physical gold (or add to your existing position) well below the recent highs.
The story about exploding debt issuance was originally reported on our daily podcast, the USAGOLD MarketMinute, available on our mobile page at http://www.usagold.com/mobile/.
