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U.S. Treasury Bonds Heading for Day of Reckoning

Interest-Rates / US Bonds Mar 27, 2009 - 01:18 AM GMT

By: Money_and_Markets

Interest-Rates

Best Financial Markets Analysis ArticleMike Larson writes: The U.K. Treasury held a bond auction on Wednesday morning. On the offer were 1.75 billion pounds ($2.55 billion ) worth of 40-year “Gilts” — the U.K. equivalent of U.S. Treasuries. There was just one problem …

Buyers went on strike! They offered to purchase just 1.63 billion pounds ($2.37 billion) of debt.


That was the first “failed” auction of traditional debt in the U.K going all the way back to 1995. And the market's reaction was both swift and severe: Gilt prices plunged and interest rates surged.

Why should you care?

Well …

After Wednesday's failed debt auction, the folks on Downing Street can't be getting much sleep.
After Wednesday's failed debt auction, the folks on Downing Street can't be getting much sleep.

Like the U.S., the U.K. is bailing out its major financial institutions. It nationalized mortgage lender Northern Rock, bailed out Royal Bank of Scotland to the tune of $38.6 billion, and agreed to take as much as a 75 percent stake in Lloyds Banking Group.

Like the U.S., the U.K. is running huge deficits. It has racked up a record 75.2 billion pounds ($109.2 billion) in red ink in the first 11 months of the current fiscal year … more than triple the year-earlier 23 billion pounds ($33.4 billion). This puts the U.K. deficit on track to hit a whopping 11 percent of gross domestic product by 2010.

Like the U.S., the U.K. is borrowing gigantic sums of money as a result. The government wants to sell a record 146 billion pounds ($212 billion) worth of debt in the current fiscal year. That should drive the U.K.'s national debt to a record 1 trillion pounds ($1.45 trillion).

Like the U.S., the U.K. is engaging in a policy of “quantitative easing.” The Bank of England recently announced plans to print money and buy as much as 75 billion pounds ($108.9 billion) of corporate and government bonds.

In other words, the U.K. and the U.S. are doing many of the same things … making many of the same policy mistakes … and relying on the kindness of strangers to fund the biggest deficits of all time. Will the day soon come when the U.S. Treasury holds an auction, and no one shows up?

Bank on it!

“Dangerous Unintended Consequences”

That's the title of the white paper Martin just presented to key media and policy makers in Washington. And it couldn't have been better timed, given this week's gilt auction failure.

As we first warned in a September 25, 2008, press release , the U.S. government is biting off way more than it can chew. The Treasury, Federal Reserve, FDIC, and Congress have now lent, spent, guaranteed, or committed roughly $13 trillion to bail out the financial industry and attack the credit crisis.

But policymakers are committing these enormous resources in a misguided way. They're showing no willpower to make the difficult choices needed to properly resolve the crisis. They refuse to allow large institutions to fail and see them through the receivership process. Instead, they're opting to prop them up with endless injections of taxpayer money.

CBO Director Peter Orszag is expecting a $1.85 trillion deficit this year, which means we'll have to sell a humongous amount of debt.
CBO Director Peter Orszag is expecting a $1.85 trillion deficit this year, which means we'll have to sell a humongous amount of debt.

As a result, they are prolonging the economic downturn. They're also transforming a Wall Street debt crisis into a potential debt crisis in Washington. Already, the cost of insuring U.S. sovereign debt against default is surging. And while no U.S. debt auction has failed — YET — I believe it's only a matter of time.

Look, the amount of money we're planning to spend in the coming couple of years is simply astronomical. The Congressional Budget Office (CBO) is already estimating the deficit will total a whopping $1.85 trillion, or 13.1 percent of GDP, this year and $1.38 trillion, or 10 percent, next year. These are the worst readings recorded in the post-World War II era!

But we don't have that kind of money in the kitty. So we have to raise it by selling debt — massive amounts of debt. In fact some weeks, including this one, Treasury is selling almost $100 billion in longer-term debt. That's the most in U.S. history. And total net borrowing for the current fiscal year could rise as high as $2.5 trillion! That will drive our national debt load ($11,041,711,544,305.34 as of Monday) even higher.

What this Means For Long-Term Bonds

Foreign investors have already started unloading “agency” debt — bonds sold by Fannie Mae and Freddie Mac. In addition, China has warned that it's getting nervous about its massive U.S. Treasury holdings.

So is it too much to imagine that U.S. bonds will soon have their day of reckoning? I sure don't think so.

And yet, Washington and Wall Street keep whistling past the graveyard on this score. They figure: “Well, no auctions have failed yet, so none ever will. Full speed ahead!”

We all know how that dangerous, short-sighted thinking paid off during the housing bubble. Let's hope our policymakers take a longer-term view this time around. We simply have to figure out a way to get us off this unsustainable debt treadmill … before it's too late. In the meantime, continue to stay the heck away from long-term Treasuries.

Until next time,

Mike

This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com .

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