Benson's Economic & Market Trends
April 8, 2010
"A Trillion Here, A Trillion There....."
"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.