Treasury Debt Issuance

There is a very good article from ZeroHedge on the coming Treasury debt issuance resulting from the Covid-19 government-imposed shutdown. Goldman Spots a Huge Problem for the Fed. ZH is obviously well connected to the inner workings at Treasury and the Fed via sources with TBTF like Goldman Sachs, JP Morgan, and individual analysts. ZH provides excellent analysis of Fed and Treasury policy and data. ZH orients its analysis in the Austrian view rather than the Classical view. The two views are very close, or indistinguishable, in most economic analysis.

ZH analyses the monetary effect of the massive Covid-19 related Treasury debt issuance. In a pre-2008, normalized, traditional Fed policy environment, the market would absorb Treasury issuance. The Fed would purchase treasuries of limited duration solely to maintain the value of the dollar under whatever monetary theory it happened to be operating at the time. The intent of the Fed’s creation through the Federal Reserve Act was to prevent the Fed from monetizing debt.  Congress designed the Fed’s statutory requirements to limit its monetary role to maintaining the value of the dollar and acting as lender of last resort. That’s why the Fed makes open market purchases from primary dealers instead of buying directly from the Treasury. The Fed is as unrecognizable from its 1913 founding principles as the dollar is from its 1913 value. 

The unleashing of post-2008 GFC QE has changed traditional Fed policy and thrust the Fed into the non-monetary role of fiscal intervention. The Fed is learning that once taking this path, its demand-side economic model offers no solution for returning to normalcy. The Fed’s weak attempt at normalization of its balance sheet ended with a whimper in December 2018.  The Covid-19 shutdown has vastly escalated direct Fed fiscal intervention. The Fed is back to full-speed balance sheet expansion with a vengeance.

ZH raises the question of who will purchase the coming tidal wave of near-term Treasury debt? If the Fed does not monetize it, the market will have to absorb it. The Fed would lose control of interest rates. Manipulated interest rates to the zero bound are what sustain our enormous debt loads and budget deficits. Market set interest rates would make the debt unsustainable with dire budgetary consequences.  

One solution, becoming increasingly apparent, is to go the BOJ route, but that requires that the Fed effectively nationalize the TBTF banks. The BOJ has nationalized its sovereign debt market and is in the process of nationalizing its equity market through ETF purchases. To go the BOJ route seems unlikely. The U.S. dollar is the world’s reserve currency and requires free convertibility, capital flows, and price discovery to maintain that status.   

The massive debt issuance is perilous economic policy, and the Fed’s demand-side monetary model has no answer for it other than more of the same. Eventually, nationalizing banks–theoretically–becomes the only solution for the Fed to maintain control. It can’t allow the market to set interest rates.  Everything would collapse.  But at the same time, the Fed can’t keep monetizing the debt in increasing amounts without destroying the bond market. A conundrum that Greenspan could appreciate. The budget would become unsustainable without manipulated zero-bound interest rates–likely headed to negative territory if Trump gets his way. Only via a trend toward nationalizing banks, can the Fed keep the massive supply of base money on banks’ balance sheets as excess reserves doing nothing and earning nothing.

An interesting observation from the ZH story is that the Fed will require a new market crash to justify more QE necessary to buy the oncoming treasury tidal wave. That seems more conspiracy-minded, but who knows. Anything is possible in the age of a particularly nasty seasonal respiratory flu that manages to shut down the global economic system. 

All of this remains positive for the price of gold regardless of how it eventually turns out. There is a real chance for an explosive rise in the POG, depending on what the Fed does and how the Treasury debt issuance gets absorbed.

In the above scenario of the Fed’s no return, box canyon monetary intervention, the solution is growth. Growth requires a return to stable money via a gold standard at the current optimum POG, fiscal relief through lower taxes (specifically capital gains), and limited government. It’s impossible to see that happening. It requires too big of an intellectual leap, and there’s no political or economic backing for it. Meanwhile, Trump perpetuates the economic despair by advocating for the hopelessness of negative interest rates.

We’re now at the 50 years/half-century mark of the global fiat monetary experiment. Change plays out over a long timeline.

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