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December 30, 2009
Now that 2009 has come to a close, investors are looking forward to the happenings
of 2010. One of the most important events is the issuance of nearly $2.2 trillion
in Treasury bonds to fund government spending. Although $2.2 trillion seems relatively
small compared to a federal debt just over $12 trillion, the size is magnified when
you consider its impact on the markets.
2009 Treasury Sales
The 2009 Treasury issuance was relatively tiny due to the amount of quantitative
easing enacted by the Federal Reserve. To help ease the credit markets, namely the
Treasury markets which allow the government to spend money, the Federal Reserve
printed over a trillion dollars and purchased several hundred billion dollars of
US Treasuries, as well as nearly $1 trillion of “agency debt” or mortgage-backed
securities.
After the Fed’s buying spree, there was only $200 billion in fixed income remaining,
creating a net issuance in 2009 of $200 billion. Of course, $200 billion is virtually
nothing when it comes to the world economy and the amount of money in existence,
and thus, $200 billion was consumed relatively easily, with no real impact on the
marketplace.
The Situation in 2010
Fixed income issues are set to increase from $1.75 trillion to $2.25 trillion next
year, with the difference mostly comprised of heavier borrowing by the Federal Government
via the Treasury markets.
Unfortunately, the Federal Reserve has only $200 billion remaining in its quantitative
easing fund to buy agency debt and US Treasuries, and the funds will only last until
March under the program enacted early last year. This leaves a total of $2.05 trillion
unfunded that must be borrowed to keep government programs in the black – at least
with capital and not actual earnings.
Therefore, in the next year, the US Treasury will need to borrow more than $2 trillion
without the help of the Federal Reserve. China has already said it is limiting its
purchases of US Treasuries, and the government is proving its resolve by redeeming
long-dated bonds and rolling them into short term debt. Other purchasers, such as
Japan, have their own financial problems. The remaining countries, institutions,
and other investors aren't too keen on earning low rates on what is quickly becoming
riskier debt.
What is the solution? The Fed will simply need to print more money.
The Fed Will Have to Step in with its Printer
Remember, this recession was triggered due to a shortage of credit. To aid in both
creating credit, as well as providing short term loans to businesses and government,
the Federal Reserve began to create money to ease the burden. As a result, the Fed
bought more debt than anyone else by a factor of 10.
Moving into next year, with the same credit problems and net issuance of $2.25 trillion,
the Fed will have to further its quantitative easing (inflation) programs to keep
the Treasury markets liquid. Should the Federal Reserve continue to print money
to gap a shortfall in Treasury sales, the creation of $2 trillion would create inflation
of 25% overnight. Obviously, as in all markets, inflation will not come out of the
woodwork for a period of months and possibly up to two years, but it will eventually
reach the market. Subsequently, in 2010, investors of all types need to be incredibly
prudent with their money and protect their assets with precious metals.
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