After more than three months of having been "frozen" at a debt limit of $US 6.4 TRILLION, the US Treasury got its credit card limit lifted this week - by $US 984 Billion to $US 7.3840 Billion. Thus far, that has generated financial rejoicing across US paper asset markets. Whoopee!! We can borrow again.
Late last year, as the Treasury was nearing its $US 6.4 TRILLION debt limit, the Fed first flew the warning flag of "deflation". Then, on February 20, 2003, the Treasury froze its debt "subject to limit" at $US 6.399975 TRILLION. The Dollar's descent accelerated and US stock markets went into the tank. Then came the Iraq war, as a kind of "stop gap" measure. Gold tanked, the Dollar stopped falling, and the US stock markets rebounded. In the eight trading days between March 11 and March 21, the Dow soared 998 points. In percentage terms, it was its biggest leap since late summer 1982.
The war didn't last very long (the "peace" threatens to stretch out endlessly), financial concerns retook centre stage, the Dollar started falling even faster, and Gold recovered. The US House of Reps passed the bill raising the debt limit on April 11, but the Senate did NOT. Treasury debt remained officially frozen. As a result, at the beginning of May, the Fed flew the warning flag of "deflation" again. .
Now, in the last week of May, the Senate has passed and Mr Bush has signed into law the bill which raises the Treasury's debt ceiling by almost $US 1 TRILLION. To the great relief of the US financial system, which relies on an ever increasing flood of "liquidity" for its very existance, the debt cornucopia which is the US Treasury is again free to function.
It was a close run thing. Treasury Secretary Snow let it be known nearly a month ago that the Treasury would hit the wall on May 28, the ceiling was lifted with days to spare. Over the month of May, the Bank of Japan spent 4 TRILLION Yen (about $US 34 Billion) propping up the Dollar. That beat its previous record of 3.2 TRILLION Yen, set in September 2001, by 25%. The faster the Dollar has fallen, the faster foreign Central Bank holdings of "foreign reserves" (read Dollars) has risen. Foreign Central Banks are nearing the $US 1 TRILLION level of these holdings. As of May 30, the figure was $US 927.7 Billion with $US 40.7 Billion having been added over the past four weeks.
But now, the punch bowl has been refilled. The initial reaction has been another surge (after two weeks of going nowhere) on US stock markets, a "pause" in the upward thrust of Gold, and a $US index which has (temporarily?) stopped going down.
In one of his recent "question and obfuscation" (sorry, we mean "answer") sessions, Mr Greenspan was asked about the risk of a concerted foreign sell-off of Treasury paper. Mr Greenspan replied that such an event was certainly possible, but highly unlikely to become disorderly. He went on to imply (he didn't state it) that the foreigners had so much Treasury paper that they had nowhere else to go. Well if the US Treasury (and the Fed) now have their way, then the rest of the world will REALLY have nowhere else to go. Fasten your belts for a wild ride over a veritable niagara falls of new US Treasury debt paper.
There have really only been two instances since WWII when such an acceleration of US debt issuance has been balked at by the rest of the world. The first came in the late 1960s when France under Charles de Gaulle decided to send back the Dollars and leave with the Gold. In 1971, that avenue of escape was cut off. Then, at the end of the 1970s as US Treasury debt hit the $US 1 TRILLION mark, the rest of the world balked again and then Head Fed Volcker was forced to "stop targetting US interest rates". The result of THAT little adventure was that US rates soared (above 20%) to provide a reward commensurate with the risk of holding Dollars. That one worked.
Needless to say, neither "cure" can be applied this time. The US financial community, and most of Main Street as well, have managed to convince themselves that there is NO risk attendant on borrowing. After all, look at the level of US interest rates. Their "balance sheets" reflect this conviction, as does the Federal government's "balance sheet". ANY increase in US interest rates would tip over the entire apple cart.
How the US is going to maintain a viable currency in a situation in which it has just embarked on a HUGE orgy of new currency creation while holding interest rates as close to Zero as to make little difference will be grist for the mill for generations of future economic historians. Suffice it to say here that they obviously think they can.
Gold has stalled this week as financial "business" returns to usual. The credit dam has had its spillways reopened and "liquidity" is flashing prettily in the sun as it surges forth to drown the world. EVERYBODY is refinancing or raising new capital. South Korea, which last floated a debt issue overseas in 1998, is doing it. Adelphia in the US, which is operating under "bankruptcy protection", is doing it. And the official Treasury debt figures have jumped almost $US 100 Billion in the three days since the debt limit was officially raised.
You might have noted the fact that the two instances when the rest of the world balked before the US Dollar flood (in the late 1960s and the late 1970s) were both followed very quickly by BIG jumps in the $US Gold price. You also might have noticed that the "cures" for the first two episodes (the beginning of the "floating currency regime" for the first and almost two years of 20% plus interest rates for the second) are not available this time.
If the "solution" to human wealth, happiness, and well being was simply to print more money, then we should all have long since entered nirvana. It isn't. All that is going to happen now is that the day of reckoning, when it comes, will be worse than it would have been before this hike in the Treasury debt limit.