Running Low On Money At The Federal Reserve

The theory about how the government can hold down interest rates is simple and naive. The Treasury will raise hundreds of billions of dollars in global markets where access to credit is already tight. That will make the US government have to pay higher rates to lure investors who have become increasing concerned about US deficits.

Part of what will save the Treasury from having to pay extraordinary premiums to raise capital is a program put together by the Federal Reserve to buy US debt thereby reducing the supply of notes attached to American deficit financing. It is a clever solution, but, as time passes, its success looks more and more improbable.

According to Bloomberg, “The Federal Reserve isn’t capable of offsetting the `flood’ of U.S. Treasury borrowing with its bond-purchase program, which is helping to revive credit markets, Dallas district-bank President Richard Fisher said.” A belief that the Fed could mitigate interest rates on US paper has been an important part of the government’s public relations push to explain how federal agencies can work together to cut the eventual tax burden on US citizens. Taxes do not have to go up much if the Treasury’s debt service payments stay down.

The American economy may well need the stimulus package put in place by the Administration in an attempt to keep job losses low. That has not worked as unemployment has risen to near 10%, and the likelihood that it will stay in double digits for several months has increased. If the priming of the pump does not work well enough, either the economy will fall back into recession, or the Administration can go back to Congress for more funding. Either choice is bound to cause a raucous reaction from taxpayers.

The Fed never had access to the capital to offset the effect of government borrowing. Its initial attempts to make a dent in the debt load may have kept interest rates on Treasuries down for a brief time, but,as it become clear that there is no “white knight” and yields are bound to rise again.

The chances that the deficit will move toward a modern record as measured against GDP increase as each month passes. Keeping American workers at work is likely to insure that.

The only real question left is how high will the rates that the Treasury has to pay will go.

Douglas A. McIntyre