In the last ten years we’ve had three bubbles: the stock market bubble; the housing bubble and the commodities and oil bubble. The next bubble is on its way, and it’s the Treasuries bubble. As Bloomberg noted, the bill for the financial crisis is now up to 7.7 trillion. Most of that hasn’t actually been paid for yet, and paying for it means issuing treasuries to expand the Fed’s balance sheet to meet the size of its obligations, as well as money for Treasury, the FDIC and so on.
It won’t be the full 7.7 trillion, but it’s in excess of 5 trillion still to be issued. That’s one hell of a lot of treasuries. The influx of money into the US to buy treasuries has been the cause of the dollar soaring. Money will have to continue to flood into the United States to fund this, and will likewise need to gush over to Europe, Japan, Korea and other countries who are throwing money at the financial crisis.
This is going to be a very Darwinian period, and it’s going to cause a lot of countries on the periphery, including most of Africa, South America and good chunks of Asia, to shake apart. All that money coming into the 1st world will mean no money for them. Combine that with a complete crash in commodities prices and they will be starved for hard currency. Since most of these nations are not able to feed themselves, this will mean famines, starvation, food riots and fallen governments. Of immediate concern to the US, barring massive US help, I would expect that Mexico will slip into indisputable anarchy in large areas of the country within a year or so.
Now when you’re talking trillions of dollars you’re talking real money. In a normal financial crisis after money repatriates and causes a spike, the value of the currency usually depreciates. But the US isn’t a normal country and the dollar is still the world’s reserve currency. Moreover the US economy is in play. Dollars may yet be able to be used to buy up real assets for multi-generational low prices. On the other hand, America keeps making it clear that the real gems aren’t on the table for foreigners to scoop up (say the Chinese buying GM or Arabs picking up a major bank.)
The fear, then, is that at some point during this giant buying spree, the rest of the world decides to stop buying treasuries. The Fed is aware of this risk, and one of the things they’ve done is start paying interest on treasuries. Oh, they don’t call it that, but when you pay interest on reserves and when treasuries count as reserves, that’s what it amounts to. So the real return on treasuries, if you’re a bank, is rather higher than ordinary people get. And most foreign banks have US subsidiaries where they can park the treasuries to get the return. (This isn’t the only reason they did this, there are other advantages to the Fed, more on that a later date.)
Assuming the rest of the world doesn’t blink, the end result is a huge treasuries bubble consisting of primarily short term treasuries and large reserves for banks earning interest rather higher than they would otherwise. Most of the money is being used for loans to banks, at lower interest rates than they will be earning on treasuries held in reserves, leading to a further outflow of money to the banks. This is, as they say, a feature, not a bug, since banks still need more money.
In principle, because treasuries count as capital and reserves, this then becomes money the banks can lend. Whether they do so will depend on whether they feel the need to horde cash against further possible losses; whether they think they need to keep cash in order to buy up competitors and what the inflation rate is at. If it’s deflationary, then making a couple percent will actually be acceptable, and in a high risk environment, they may just decide to sit on the treasuries, which is hardly what the government would like them to do.
And meanwhile countries from Pakistan to Morocco to Venezuela will be shaking apart.