Last week we mused that one of the reasons for QE1, QE2, QE, etc, was that the US government simply cannot pay its bills, and like any the tail end of any Ponzi scheme, is starting to get desperate. Like a drug addict who has cleaned out his pockets, it’s time to start stealing from the neighbours.

While this view seems outlandish (that is, the US Fed printing money to pay the debts of the US government), Bill Gross, who runs PIMCO (the world’s bond king) noted last week that, “nearly 70% of the annualised issuance (of treasuries) since the beginning of QE II has been purchased by the Fed, with the balance absorbed by those old standbys — the Chinese, Japanese and other reserve surplus sovereigns.” Or as the fantastic Greg Canavan of the Daily Reckoning put it – “in other words, there are no economic buyers of recently issued US government debt”.

This is a bit of a problem. Especially when you are trying to fund a massive welfare system, with 40 million Americans receiving food stamps — and Medicare, Medicaid and two absurdly expensive wars that almost no one, other than Fox News employees and those who work at the Pentagon, actually still think should be occurring (Perversely, it seems that Facebook has been a greater facilitator of regime change than the world’s largest military force).

The US budget deficit is $US1.6 trillion — yes trillion. That is equal to about $US11,000 for every employed American (the total US debt is $US14 trillion, of $US45,000 for every single person — man, woman, child, prisoner, invalid, etc).

Markets clamor upon every piece of good news in some sort of bizarre positive feedback loop, pushing the US stock market to absurdly high levels. The broad S&P500 index closed last week at 1321 — that is only 18% lower than the all-time high reached in October 2007, shortly before the first wave of the GFC. Of course, since October 2007, unemployment has risen from 4.6% to 9% (but it is actually more than double that number when you consider those who gave up looking for work). House prices have fallen by almost 40% (and are at nine-year lows) and oil, the hidden tax, is once again threatening to break well clear of $US100 per barrel. (Oil has hit $US104 a barrel, the highest level since September 2008, while gold and silver are at 30-year highs).

So far, the Fed has been able to dupe global markets into keeping the US dollar as the world’s reserve currency. This has allowed it to print trillions of US dollars but not see a complete destruction of the US dollar. But as Nouriel Roubini wanted last week, “the risks that the bond vigilantes wake up in the US”.

Bond vigilantes are investors who will sell treasuries of a country when they believe the authorities are debasing the currency. When this happens, the authorities lose whatever minimal control they had over the cost of money (interest rates). This is effectively what is happening in places such as Ireland and Greece, who are being forced to pay interest rates of 9% or more on their borrowings, because lenders perceive them to be a higher risk.

It is a matter of time before bond investors act on the realisation that the US deficit is unsustainable (hence the need for the US to buy its own debt) and force up the interest rates needed to be paid on borrowings.

When that happens, watch out.

Peter Fray

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