The following is a paper published earlier this week by former Sempra Metals economist John Kemp looking in detail at the Fed’s emergency money market operations and its ultimate reliance on Chinese support. It’s a long read - 5,000 words - so we’ve split it into five parts. If you would like an accompanying selection of charts that are simply too large to publish here email alphaville@ft.com.
The Fed itself has basically run out of money. While the Treasury can continue borrowing to support the central bank, the government is already getting close to the debt ceiling. Before the passage of the Emergency Economic Stabilisation Act, Congress had authorised the Treasury to borrow up to $10.615 billion. By the end of last week, the Treasury had already borrowed $10.120 billion, and had just $494 billion worth of unused borrowing authority left. The Stabilisation Act raised the statutory debt limit by a further $700 billion to $11.315 trillion. But that was done to allow the Treasury to raise money to buy up to $700 billion worth of troubled assets under the TARP; it has no effect on the amount of borrowing authority the Treasury has for other programmes.
So the Treasury still has around $494 billion of unused borrowing authority left. That gives it some scope to raise more funding through the sale of cash management bills, but it cannot keep up the current pace of borrowing very much longer. More seriously, it will be using up borrowing authority that it needs for the coming year.
The respected non-partisan Congressional Budget Office (CBO) is already projecting a budget deficit of more than $400 billion in fiscal 2009, and the tax breaks included in the Stabilisation Act to secure its passage second time around by the House of Representatives will increase the deficit further. At the very least, the US Treasury will have to come back to Congress within the next few months and ask for a further substantial rise in the statutory debt limit. Borrowing to support the financial system looks set to crowd out the government’s ability to borrow in order to fund tax cuts and domestic spending programmes, sharpening the budget dilemmas for the incoming administration and Congress next January.
But all this borrowing threatens eventually to undermine the market’s confidence in the financial position of the United States. Of the $10.120 billion of US government debt outstanding at the end of Oct 3, $4.272 trillion had actually been sold to other government entities such as the Social Security and Medicare Trust funds, and was largely an internal accounting transfer. Only $5.914 trillion had actually been placed with the public. The amount of debt placed with the public has already surged +9.5% from $5.401 trillion at the start of Aug and +17.0% from $5.057 trillion at the start of fiscal 2008 in Oct 2007. The $700 billion for the TARP will add even further to the rapidly growing mountain of public debt that has to be sold to the public.
For the time being, the market’s demand for ultra-safe instruments is so huge that the Treasury is having no difficulty placing all the paper it wants at little or no interest. But the cash management bills are all very short term, and the Treasury will soon start having to roll them continuously, or fund them by issuing longer-dated securities, and the longer-dated securities will be much more expensive in terms of interest costs. Funding could become much more difficult once the immediate crisis, and the associated safe-haven flows has passed.
More worryingly, all this borrowing by the US Treasury threatens to crowd out borrowing by the banks and the private sector. I have never really believed in the strict versions of the “crowding out” theory, and the problem is somewhat theoretical at the moment, since the banks and most corporations cannot really borrow from the market at the moment in any event, so the Treasury borrowing is not really crowding them out in any meaningful sense. In fact the Treasury is borrowing into what would otherwise be the vacuum created precisely because others cannot borrow.
But sooner or later, the private sector will need to restore its access to the capital market, and the Treasury’s massively increased public borrowing requirements, up by more than 25% in a year, could start to create problems. Either households and corporations in the United States must be persuaded to save more, and buy more of both government securities and private notes, or foreign investors must be persuaded to increase their holdings of US government paper.
In either event, borrowing costs for both the government and the private sector look set to rise in the medium run, at least in real inflation-adjusted terms. It is notable that the cost of long-term government borrowing through US Treasury bonds has only declined to 3.45% despite the near-collapse of the rest of the financial system, not lower than during some of the troughs of the last recession, when economic conditions were difficult by the financial system was still functioning normally. So for term borrowing, rather than overnight cash, the government’s funding cost is cheap, but not that cheap. Borrowing costs for the private sector have continued to rise even for the highest grade credits. Some of this is due to immense uncertainty about the repayment capability of even high-rated corporations at the moment, and should eventually unwind when the crisis abates. But corporate borrowing costs look set to re-rate upwards in the medium term.
Continued…
