But Congress will still want to sell its trillion dollars worth of debt each year, right up against Uncle Ben’s Crazy Treasury Fire Sale.
Let’s assume all this happens about four years from now. By then, we’ll already have outstanding debts of about $20 trillion. And most of that debt is in short term treasuries of two- or three-year maturities. Now, as that debt matures, we can do one of two things. We can roll it over into new debt (refinance), or we can pay it off and send folks home with oodles of cash money.
Stop laughing. We could so pay it off. In some other reality.
Last year we had to refi almost three trillion in existing debt, on top of the trillion in new debt Congress created. So when we get to this next part, I want you to remember that there is already no market big enough to gobble up four trillion dollars in US debt. It doesn’t exist.
When and if that recovery comes, we’ll have Congress still trying to scare up buyers for a trillion dollars in debt each year. We’ll have the Fed trying to unload some unspecified number of trillions — nobody other than The Bearded One is allowed to know that number — in fairly short order. And we’ll have the Treasury trying to refi three, four trillion or more dollars, each and every year.
In a global marketplace that could only buy (or re-fi) a little over three trillion dollars, we’ll have to find the wherewithal to soak up five or six trillion dollars.
Hey, buyer’s market! Think of it — the Treasury, the Fed, Congress, all trying to sell you trillions. They’ll really have to jack up interest rates, won’t they? treasuries you wouldn’t sniff at when they paid out 2% start looking pretty good at 4%, don’t they?
Oh, wait… that’s only for the new debt Congress issues, and for the old debt being re-financed. What about the trillions Ben needs to unload?
Well, kids, here’s where we need a very quick lesson on how bond markets work. A bond pays out a fixed interest rate, no matter who holds it. So let’s say I paid face value for a $100 treasury paying 2%. My $100 investment pays me $2 every year. (Actually, every 360 days — but that’s another lesson.) Now I want to sell that instrument, but interest rates have doubled to 4%. Who’s going to buy my old $100 at 2%, when they can buy a shiny new $100 bond at 4%? Well, nobody. Nobody would be willing to buy at face value.
Instead I offer to sell you my $100 bond for $50. The bond still pays the same $2 a year to you, even though you bought it at half price. And a $100 at 2% bond you bought on the secondary market for $50, gives you the same rate of return as a new $100 at 4% bought at face value.
Ben needs to sell old debt. Tim Geithner at Treasury needs to refi existing debt. Congress needs to issue new debt.
Congress will be the ones offering jacked up interest rates. Ben and Timmy will be the ones offering steep discounts. And this is where the whole system breaks down.
Ben’s problem is the discount he’ll have to offer. If rates really do double to 4% (which is historically still quite low) he won’t be able to take all of his Make Believe Dollars out of circulation. In fact, he’ll only be able to soak up about half of them. Say hello to my leetle fren, inflation.