I am often asked what signs I use to measure where we are in the crisis and whether it will get worse or better.
This next article posits the emergence of a new type of bond sold by the US that is not denominated in US dollars. This would be the equivalent of a road sign reading, “No bridge, 10 feet.”
Here’s the idea:
Japan economists call for US borrowing in other currencies
TOKYO – Japanese economists, increasingly concerned that the United States might seek to pay its enormous and growing debt obligations in a weakened US dollar, are looking to the possibility of US Treasuries being issued in yen.
Few truly appreciate what a gift, and exorbitant privilege, it has been for the US to be able to both issue and pay off its debts in the same currency. Compare this to a third world country forced to borrow from the IMF in another currency. In order to pay back the loan, they have to acquire whatever that currency happens to be. This means that they must run a positive trade balance of some sort or they may have to sell off key internal assets. Either way, a rigor is imposed on their actions that is missing for the US.
The US government needs to borrow at least US $1 trillion in the coming year, excluding the US Treasury’s $700 billion plan to bail out the financial and other industries, said Kazuo Mizuno, chief economist in Tokyo at Mitsubishi UFJ Securities Co, a unit of Japan’s largest publicly traded lender by assets. That amount is likely to grow as the US government continues to rescue failed parts of the economy and has to raise more debt – that is, issue government bonds, or Treasuries – to fund such rescues.
My comment here is that if Japan is already worried about $1 trillion in borrowing, wait until they find out about the $2 trillion in borrowing. A good understanding of the Treasury market funding cycle helps here too. Because it is not just the $2 trillion in new borrowing that must be accommodated. There is roughly $1.8 trillion in “roll-over” funding for past borrowing that must occur as well. These are enormous numbers that will vastly exceed total world savings next year, if my predictions about the downturn are correct.
Faced with the unprecedented growth of the US budget deficit and the prospect of an increasingly weaker dollar compared with the yen reducing the value of Treasury debt held by Japan, economists in Tokyo are calling for the administration of president-elect Barack Obama to issue US Treasuries denominated in yen and other currencies. The issuance of foreign currency-denominated US Treasures would reduce the perceived risk of holding the debt.
And that, my friends, was a call for the beginning of the end of the free ride. If (or when) the US is forced to borrow real money from other countries that it cannot simply print out of thin air, then it will have to work for it, like everybody else. This will mean that our trade balance must be, at worst, zero, or else our currency will constantly erode. While a weaker currency can help the exporters, it also means that the cost of external borrowing goes up, which can quickly morph into a borrowing spiral,where a weaker currency and more borrowing create the conditions for each other’s existence.
Unthinkable? Well, no, it’s happened before.
The idea of issuing foreign currency-denominated US Treasures is not new. The Jimmy Carter administration, buffeted by the two oil crises of the 1970s, sold "Carter bonds", denominated in German marks and Swiss francs, in 1978 to attract foreign investors into Treasuries.
“Carter bonds” they were called. And what will these bonds be called then?
"The US will be forced to issue foreign currency-denominated US Treasures in its hour of need," said Mizuno. "The US cannot finance its deficit by itself. The US financial system cannot survive without foreign investors. We will see ‘Obama Bonds‘ in the future."
“Obama bonds." Interesting ring to that.
Right now this is all conjecture, but if or when the US begins to issue bonds in foreign currencies to fund its excesses, then this will be a road sign that the end of the old paradigm is upon us.
Caution: Bridge out
For now, I am keeping a close eye on this ‘trial balloon,’ as the denomination of US bonds in anything other than US dollars would be a tectonic shift for the US and for the global economic landscape.