Planting the seeds of a cash crisis

Dear editor:

A little research on treasury bonds; I learned that fully 40 percent of the over $9 trillion in Treasury debt currently outstanding to the public has a maturity of three years or less. Think what this means, that we are rapidly approaching $4 trillion in U.S. debt that matures by 2014 or sooner. Right now the yield (interest rate paid) on a two-year Treasury note is about 0.645 percent or about 2/3 of a percent.

The yield, at the same time, on a 10 year Treasury note is 3.4 percent, and on a 30 year is 4.55 percent. In bond parlance this is called a "steep yield curve" where interest rates get much higher as you go farther out in time.

Clearly, the Treasury is doing this for a reason. By issuing mostly short-term notes, the Treasury is paying less interest, thereby keeping interest costs and, consequently, the deficit down. In addition, the Federal Reserve is in the middle of it "quantitative easing #2" (QE2) under which it is buying $600 billion of our own Treasury debt over about a six-month period.

The Fed is not buying the short term notes, but is buying 10 year maturities and longer in order to hold those rates down.

And, since the Fed is earning the interest thereon (paid by the U.S. Treasury), it is improving its yield. We are currently running a deficit of about $130 billion per month, so the Fed is basically buying all of the new bond issuance from the deficit for almost 5 months.

What does this mean? I understand that the Fed and the Treasury are trying to keep interest rates low and improve the economy and the deficit. But, when coupled with huge deficits, these moves look a bit like a Ponzi scheme that will go South soon!

We are printing money ($600 billion) to buy our own debt so that the full effects of the deficit are not felt. We are buying long-term bonds to artificially hold down the rates on those bonds since home mortgages and many other things are based on these rates.

We are selling short-term bonds at cheaper rates to hold down costs now, but are leaving ourselves open to huge cost increases when interest rates go up. If interest rates go up 3 points (similar to 2008), our deficit would increase by another $150 billion per year, even if long-term rates stay the same.

The Fed can cure a bunch of this simply by printing a lot more money. That will create an inflationary period with wealth loss and a very sick economy.

In the years 2005-2007 we planted the seeds of the financial crisis of 2008, by creating too much credit (leverage) in the private sector. But few people could see it coming. Today, we are planting the seeds of another crisis with too much leverage in the public sector. This time it's easy to see coming!

-- Nathan Jones, King Hill