Two stories from two different sides of world today seem to indicate that we’re going to have to pay a price for all this deficit spending.
First, the United Kingdom had a bond auction today; except they ran into a problem when nobody wanted to buy:
Today, the UK suffered a failed auction for the first time since 2002. The Debt Management Office received bids for just £1.63 billion of a £1.75 billion offering. As the government has to sell nearly £150 billion of gilts in the coming (2009-10) financial year, this is hardly an encouraging sign.
To the casual observer, it might seem unsurprising that investors turned their nose up. They were being asked to lend money at 4.5% for 40 years to a country that, even in the midst of a recession, has an inflation rate above the government target, has a deficit expected by the IMF to be 11% of GDP next year, and a currency that has fallen by a quarter against the dollar since last summer.
Then, a few hours later, the United States ran into the same problem:
March 25 (Bloomberg) — Treasuries fell as the government’s record sale of $34 billion of five-year notes drew a yield of 1.849 percent.
The yield was higher than the 1.801 percent forecast in a Bloomberg News survey of eight trading firms. U.S. securities fell earlier even as the Federal Reserve bought $7.5 billion of Treasury notes, its first targeted purchases of U.S. securities since the early 1960s. The auction was the second in the government’s record $98 billion sale of notes this week. In the U.K. today, investors failed to submit bids for the full amount of 40-year gilts offered by that government.
The yield on the benchmark 10-year Treasury note rose four basis points, or 0.04 percentage point, to 2.75 percent at 1:03 p.m. in New York, according to BGCantor Market Data.
The five-year notes sold today yielded 1.813 percent in pre-auction trading. The yield at the last five-year note auction, in February, was 1.985 percent.
One result of this news was a quick end to what had been looking like a fairly good day on Wall Street, but the consequences are potentially more serious than that, as Brad Warbiany notes:
Right now, nobody really believes that governments are going to exercise monetary prudence in the face of cratering economies. That’s true in America, and it’s true in Britain. Why would someone lend money for a 4.5% 40-year return if they honestly think inflation over that time period will ensure they lose quite a bit of money?
Governments are going to borrow lots of money, and the market is not enthralled by the lending terms they’re being offered. There are two ways to get around this. You can offer better terms (i.e. higher yield bonds), but that has the downside of letting the world know that you plan to inflate your own currency. Alternatively, you can simply print the money you need to borrow and loan it to yourself at whatever terms you want. It seems that central banks in the US and Britain are already taking that path, and the market sees the writing on the wall.
As Robert A Heinlein famously stated in The Moon Is a Harsh Mistress, there ain’t no such thing as a free lunch; or to but it more bluntly, spending trillions of dollars you don’t have does not come without a price. That price will be higher inflation, higher interest rates, and reduced to negative economic growth in the future as the market makes all of us pay for the mistakes that Washington is making.