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“A
billion here, a billion there, and pretty soon you’re talking real
money”. This phrase about government expenditures has become a
classic but with great inflation underway, it needs to be brought up to date.
Everett Dirksen (1896-1969), a Republican senator from
Illinois, is often credited with this saying. Indeed, several people
recall that Dirksen said it on The Tonight Show with Johnny Carson in the
1960s, and that Carson often used the line in his opening monologues.
The Tonight Show television archives are not easily available, but so many
people remember it that the Dirksen association with the quotation probably
was popularized there.
What
used to be a billion here, a billion there, is now a trillion. To put
that amount of money in perspective, think of a trillion dollars as a
thousand billion, or a million million. Even in an inflated world where
a cup of coffee has gone from $.25 cents to $2.50, a trillion lucky bucks
gets my attention and respect.
My
rule for investing is to never lose sight of the obvious, particularly when
it is so massive that it dwarfs everything else. With our escalating
budget deficits and US Treasury borrowing, this year we’ll see a
trillion and a half in new borrowing. And, with hundreds of billions in
mortgage losses at Fannie Mae and Freddie Mac, and massive bank failures costing
the FDIC a bundle, we should expect the same in 2011 and beyond. With
the new health care entitlement reform bill and millions of workers dropping
out of the labor force and filing for early social security, US Treasury
borrowing looks certain to remain well over a trillion dollars a year, at
least over my lifetime. There’s no question that a trillion here
and a trillion there is real serious money!
You
can’t help but wonder where the US Treasury gets all of this
money. Because US households save an average of only 3 percent of their
income, or about 2 percent of GNP, it certainly won’t come from
savings. The government needs to finance deficits equal to 10 percent
of GNP, or half of all government spending. Each month, the
Treasury Department has to find cash they can tap into to buy approximately
$120 billion of fresh new debt (about $4 billion a day). So where
exactly is the US Treasury going to find this kind of money?
Up
until now, the deficit has gotten financed with some pretty big tricks.
For instance, the Treasury recently got back over $50 billion in TARP money
from the big banks, and the FDIC passed the hat for $50 billion in pre-paying
3 years of FDIC insurance, all quickly invested into Treasuries.
Unfortunately, $50 billion here and $50 billion there won’t go very far
in a trillion dollar world.
The
really big money for the deficit has come from Quantitative Easing, or
“QE”, where the Fed prints fresh money “out of thin
air”. The Fed has just finished buying $1.25 trillion in mortgage
securities and exploded its balance sheet from $800 billion, at the beginning
of the financial crisis, to over $2.3 trillion today. That’s a
hefty $1.5 trillion increase. Foreign central banks have also been
printing money for America’s benefit, and they’ve purchased a
whopping $3 trillion of US Treasuries, including $400 billion of Treasury
debt bought in the last twelve months. (The Federal Reserve and foreign
central banks together have printed up $5.3 trillion). For now, that
has taken the pressure off financing $8.3 trillion of outstanding public
market Treasury debt.
As of April Fools’ Day, the exact total of US open market
debt is a whopping $8,294,870,658,096.94.
QE,
and all the Foreign Central Bank and Federal Reserve Bank buying of
securities, have kept ahead of the Treasury deficit. Indeed, QE has
left US banks sitting on $1.1 trillion of free bank reserves they could use
to make loans or buy more securities. Normally, banks don’t sit on free
reserves for very long and the Fed has announced they need to think about
draining reserves from the banking system to remove worries that the free
reserves might lead to inflation.
Well, you shouldn’t worry about the trillion in idle bank
reserves as they won’t last long. The US Treasury has printed up
a big sign to commemorate the wisdom of Willie Sutton. When Willie was
asked why he robbed banks, he said ‘because that’s where they
keep the money’! The Treasury has already cast its longing eyes on the banks’
free reserves.
There’s
no doubt where the Treasury will turn for finance. We are about to see
the greatest stuffing of banks with government securities the world has ever
seen. American banks will be forced to gorge on Treasury securities,
and disgorge bank reserves. Where else can the government get the next
trillion to spend on things like wars, unemployment benefits, and food
stamps?
There
are a few obvious things to think about here. At the rate of $120
billion a month, it will only take about nine months to blow through over a
trillion dollars in free bank reserves. Each Treasury auction will find
it more difficult to sell all of the treasury securities, and it will take
rising interest rates to coax out even more reserves from the banks. (When
you need to borrow over $4 billion a day, even a trillion dollars
doesn’t last long.) By the end of the year, when the bank
reserves are used up buying Treasuries, interest rates will soar and bond
auctions will start to fail. No one will have any cash left to buy
Treasuries unless, of course, central banks crank up the printing presses
again. Look for a QE II, QE III, and QE IV before the dust settles.
Without central banks, there really isn’t any source of debt buying
large enough to fund America’s deficits.
Looking
in the crystal ball that reflects the truth of what our government is up to,
our choices appear to be: i) inflate, or watch interest rates soar; ii)
watch interest rate soar, and inflate; or iii) inflate the money supply and
ultimately drive interest rates relentlessly higher. Either way,
interest rates, particularly longer term, will constantly be pushed up, while
future rounds of money printing will surely promise great inflation in the
years to come. Endless deficits of this magnitude do
have serious consequences.
Richard
Benson
SfGroup.org
Richard
Benson is the founder of The Specialty Finance Group ("SFG") was
founded in 1989 as a financial broker to private finance companies,
introducing them to major financial institutions that would provide them with
equity, subordinated debt, and senior credit facilities using the Capital
Market.
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