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Posted at 11:46 AM ET, 03/10/2011

Red flag: Biggest bond fund dumps U.S. Treasuries

By Jennifer Rubin

Last fall Jason Thomas, writing in National Affairs, explained the danger of our increasing debt:

The government borrows in a currency that it prints, and it is difficult to conceive of a situation in which it would be more advantageous for the United States to renounce obligations than to print whatever amount of dollars would be necessary to meet them. The real problem is that bond-market investors are not oblivious to this flexibility. When it appears likely that a country will print money to inflate away unsustainable debt burdens, interest rates rise to incorporate an inflation risk premium -- thus increasing the burden on the government and on private borrowers. The danger, then, is that excessive borrowing will bring investors' hunger for Treasury securities to an end, causing a spike in interest rates that could crush the American economy and send it into a debt spiral we would find very difficult to escape.

Treasury securities have continued to sell, as Thomas explained, because of "the weakness of other countries' fiscal positions, and the power of inertia and familiarity." But that can change. Thomas warned:

The Treasury market's status as a safe haven is not an immutable feature of economic life: It is a function of institutional credibility that took generations to build, but that would take just a fraction of that time to destroy. Were Treasury securities to lose their status as the global reserve asset of choice to gold, other commodities, or a different currency, the consequences for the American economy would be disastrous. Unlikely as such a scenario might seem at the moment, today's fiscal policies unquestionably increase the probability of its coming to pass.

Fast forward to Thursday and we see this Bloomberg report:

Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., eliminated government-related debt from his flagship fund last month as the U.S. projected record budget deficits. . . .

Yields on Treasuries may be too low to sustain demand for U.S. government debt as the Federal Reserve approaches the end of its second round of quantitative easing, Gross wrote in a monthly investment outlook posted on Pimco's website on March 2. Gross mentioned that Pimco may be a buyer of Treasuries if yields rise to attractive levels.

In other words, as Thomas described, Gross suspects the U.S. Treasury's excessive borrowing will necessitate a hike in interest rates and thereby set off that dreaded "debt spiral." We don't yet know whether Gross is an anomaly or a trend-setter.

Those preaching that there be no slowdown in the federal government's spend-a-thon, (which is actually a borrow-a-thon) should pay attention, if not to Gross then to Erskine Bowles, the co-chair of the debt commission.

In testimony this week before the Senate Budget Committee, Bowles had an exchange with Sen. Rob Portman (R-Ohio). Portman reminded Bowles that the Keynesians "who looked at the stimulus package and said that the roughly $800 billion -- over a trillion when you add interest on the debt -- those folks said our unemployment would be 8 percent last year and 7 percent this year. That hasn't happened." Portman then asked Bowles: "Now they're saying if you reduce spending by 1.6 percent, there would be a great loss of jobs.... What do you think the economic impact will be of reducing spending along the lines you recommended?"

Bowles said that, although not an economist, "what I can tell you from my career as a businessperson and from heading the Small Business Administration is that small businesses can't grow and can't create jobs without money. And if we don't tackle this fiscal mess that we have today, then small businesses will be crowded out of the marketplace and then there will be fewer jobs, not more jobs. If you are really concerned about jobs, then we have to tackle this problem head-on."

There is, just as Thomas explained, only so much debt you can rack up without having to entice borrowers with higher interest rates. And should the buyers of our Treasuries begin to drop away, we will, as Bowles said, strangle the recovery and impede job growth. That day may be coming faster than the big spenders expected.

By Jennifer Rubin  | March 10, 2011; 11:46 AM ET
Categories:  Budget  
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Next: Thursday feature: A turn to lighter fare


I can't understand how anyone could believe that our borrow-and-spend binge can be sustained for even a few more years. Our annual interest expense on the national debt is already more than $200 billion with interest rates at only about 3.4%. With our debt increasing by about $1.5 trillion per year, we can't expect these cheap rates to continue for very long.

Relying on the kindness of strangers to finance our extravagance, and the impending retirement of the Boomers, is an unsound economic policy.

Posted by: eoniii | March 10, 2011 12:08 PM | Report abuse

Kindness of strangers? Ehhh we do a lot of things for them as well. World's policeman, after the tsunami the ships we sent were capable of making 90K/gal each of water IIRC, we do a lot we don't get credit for.

Posted by: gopthestupidparty | March 10, 2011 12:19 PM | Report abuse

"Treasury securities have continued to sell, as Thomas explained, because of "the weakness of other countries' fiscal positions"

Look Jennifer,we have a world monetary system that is based entirely on Fiat Dollars,the fact that one kind of Fiat Dollar is said to be worth more than another is just a matter of short term opinion that a minute will revise. Thew Ponzi Scheme/Credit Bubble will collapse,just as the Tulip Bubble did,we just don't know when.
It is a fantasy to believe that Fiat paper has any more value than monopoly money. When,you play Monopoly,in order for the game to work,we pretend that it is real,but after gametime,we return to Adult realities.
Well,the bad news is that the game is still in process,the other bad news is that the game will end.

Posted by: rcaruth | March 10, 2011 12:43 PM | Report abuse

So I guess the liberal romp in Iraq to set up a Shia state aligning itself with Iran cost 1 trillion. Well, actually more when you add the interest. And the American lives. And the cost to care for tens of thousands of our real American children who need medical care, arms, legs, etc. And the cost of the children of those 4,000+ killed having to grow up without a parent. But I guess neocons would rationalize that the surviving spouses would be young enough to re-marry.

Thank goodness liberal neocons don't have to factor in a cost to the immorality of their unconservative policies. That might be a buzz kill for their excellent adventures.

Posted by: mfray | March 10, 2011 12:58 PM | Report abuse

There is an assumption that "printing" money on the order necessary to satisfy bondholders will cause inflation. There is no evidence for this. Money become inflationary when it chases goods. Unless money goes into the hands of those that would spend, there is little reason to expect inflation.

Does the Fed (the largest bondholder) want to buy "stuff"? No, Bernanke already has a nice house. Does China? No they are selling stuff to us. They could buy our stuff today but they aren't.

The other thing that you have to remember is that while the federal government may continue spending (that makes money), the private sector is de-leveraging (that makes money vanish). The net money supply is going pretty much nowhere.

Fear-mongering with mis-information isn't helpful.

Posted by: andrewbellia | March 10, 2011 4:56 PM | Report abuse

I don't take it that way at all. Bill is buying corporates and emerging market debt - in other words dumping safety and buying risk. That is a good thing. He is betting trillons of dollars that the recovery is for real. You go long Treasuries as you enter and during a recession. You go long risk during recoveries and expansions.

I think Bill Gross owes Ben Bernake a drink or at least a box of Holiday popcorn - Ben's quantitative easing program allowed Bill to unload his position at top dollar courtesy of an inflated bid from the Federal Reserve.

Posted by: sold2u | March 10, 2011 6:08 PM | Report abuse

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