How do you borrow 1.75 trillion?

[Meadmaker]

That's the newly projected deficit for this fiscal year. In all seriousness, how do you borrow that amount of money? From whom? What do you have to do to convince people to lend it to you? If you decided to do a "stimulus package" of 10 trillion dollars, could that be done?

I know that people sometimes talk about the government "printing money", but I know it doesn't really work that way. I suppose the government could loan money from the Fed to member banks, who could then turn around and invest that money in Treasury Bills, giving them a low risk investment, but wouldn't that be just like, well, printing money, and wouldn't that make inflation skyrocket?

1.75 trillion is more than 5,000 dollars for each man woman and child in the United States. We aren't talking about small potatoes. Who has that kind of money to lend?

 

[lionking]

Deficit budgeting dragged the world out of the Great Depression. I don't think there is any alternative.

 

[firecoins]

I have been looking for someone who can lend 5000 small potatoes but it isn't working.

 

[KoihimeNakamura]

It's borrowed off the promise to pay later.

 

[Puppycow]

wouldn't that make inflation skyrocket?

All else being equal it might, but consider the following: Homes in America have lost $5 trillion in market value since the peak of the bubble and are expected to lose another $5 trillion or so before bottoming out. All the equity markets in the world have lost about $30 trillion in value. Assuming about 1/4 of that is in the US, that's approximately $7.5 trillion that has evaporated. 5+5+7.5= $17.5 trillion, which is 10 times 1.75 trillion. So if you pump $1.75 trillion of new money into an economy that has just lost $12.5 trillion and has another $5 trillion to go, it would probably just make the deflation less severe.

1.75 trillion is more than 5,000 dollars for each man woman and child in the United States. We aren't talking about small potatoes. Who has that kind of money to lend?

The Chinese and the Japanese. And 5,000 dollars ain't what it used to be.

 

[Skeptic]

That's the newly projected deficit for this fiscal year. In all seriousness, how do you borrow that amount of money?

Look, dad, I'm a little short this week...

 

[soylent]

How do you borrow 1.75 trillion?

By issuing pieces of paper that can be redeemed for a certain amount at a certain maturity date and auctioning them off to the highest bidder.

What I want to know is what happens if funds are borrowed short-term(because the 1-year interest rate is significantly lower than the 10-year or 30-year interest rate) and the US government's sovereign credit rating drops as a result of taking on too much debt-to-gdp. Would the US have trouble rolling over the $1.75 trillion into new 1-year treasuries?

 

[TriangleMan]

That's the newly projected deficit for this fiscal year. In all seriousness, how do you borrow that amount of money? From whom?

Issue government securities which are then purchased by the public, banks, insurance companies, any corporation who wants low-risk investments, other governments etc.

I'm sure if you dig around the Treasury Department website or the GAO it will probably have the breakdown somewhere of what percentage of the debt is owned by what type of investor and the breakdown of the debt structure.

In this type of financial climate I can see US government securities being very popular as people pull their money out of higher-risk investments to invest it in something with less risk.

 

[plumjam]

How do you borrow 1.75 trillion?

Hmm.. well,.. are you a homeowner?

 

[Francesca R]

In all seriousness, how do you borrow that amount of money?

The US Treasury issues bonds

From whom?

I think it is mostly domestic and foreign private investors, with sovereign (foreign) investors also contributing.

What do you have to do to convince people to lend it to you?

Right now it seems sufficient to offer to pay a yield to maturity of about 3% for ten years, or about 3.7% for 30 years, in US dollars. In other words, compared to much of recent history (last few decades) not very much at all.

If that seems strange--say, because the supply of US government debt is so much larger today than over that recent history, so how come people buy it for what is to all intents a higher price--it's because their willingness to hold almost anything else has declined to a great extent. Thus, despite the global pool of savings (the potential demand pool) being smaller, and despite the supply of US government bonds being bigger, investor preferences for US government debt over almost everything else they could do with savings has rocketed to such an extent that they will accept a lower reward for lending more to the US government today than the reward they would accept to lend less to it before.

I know that people sometimes talk about the government "printing money", but I know it doesn't really work that way.

It does sometimes. It depends on who is the buyer of newly issued bonds. If global investors, as above, lend to the US government then it is not "printing money" because no increase in the US dollar monetary base ever took place. The government borrowed more money from people, but it was money they had already, and which they diverted from whatever it was saved/invested in before into newly issued US government bonds.

If, however, the Federal Reserve "bought" newly issued bonds, then (unless the Fed liquidated some of the couple of trillion third-party assets it currently owns which is not going to happen) the Fed needs to "print" new money to do that. What happpens is that the Fed credits the US government with the sale proceeds of the new bonds. If that sounds incestuous that is because it is of course. Effectively it is the same as the government rolling the printing presses itself. It's just that the accounting and the institutions involved are different (EG the Federal Reserve is not under the control of the executive branch of the US government except at an arms-length level, whereby the President appoints the chairman of the Fed for fixed terms, and the Secretary of the Treasury generally consults with the Fed chairman and does things that the Fed chairman tends to agree with)

I suppose the government could loan money from the Fed to member banks, who could then turn around and invest that money in Treasury Bills, giving them a low risk investment, but wouldn't that be just like, well, printing money, and wouldn't that make inflation skyrocket?

The government can't technically lend money without first getting it from somewhere. It is the Fed which "creates money". The government could do it if it raised taxes or borrowed it from somewhere else or sold state-owned assets, but those things don't create more money, they just shift it around.

As for inflation skyrocketing, Austrian economics aside, an increase in monetary base should cause an increase in price levels all else remaining unchanged. But there is a huge amount of "all else" that would have to remain unchanged. (The velocity of money, sometimes known as "money demand" for one). Moreover, it should increase price levels relative to what would happen otherwise. If what would happen otherwise (due to a massive slump in real final sales in the economy, for instance) is the price level fallling 5%, then monetary base expansion that offsets this would generally be viewed as a desirable policy.

 

[oggiesnr]

As for inflation skyrocketing, Austrian economics aside, an increase in monetary base should cause an increase in price levels all else remaining unchanged. But there is a huge amount of "all else" that would have to remain unchanged. (The velocity of money, sometimes known as "money demand" for one). Moreover, it should increase price levels relative to what would happen otherwise. If what would happen otherwise (due to a massive slump in real final sales in the economy, for instance) is the price level fallling 5%, then monetary base expansion that offsets this would generally be viewed as a desirable policy.

However isn't there a potential downside to this? If/when the economy returns to what passes for normal at that point the extra money could become inflationary and up go interest rates or monetary policy has to be tightened and we have to hope that the Central Bankers have their eyes very carefully on the ball so as not to under or over react and cause more havoc.

Steve

 

[Francesca R]

That's correct.

 

[Meadmaker]

By issuing pieces of paper that can be redeemed for a certain amount at a certain maturity date and auctioning them off to the highest bidder.

To whom? Who has that kind of money? At least, who has the kind of money that they are willing to lend to the US government? What if they held a bond auction and nobody came?

Built into the call for huge deficit spending is the belief that there will always be people (or institutions) to buy the bonds. At some point, that assumption will not be true. Where does that assumption break down? We managed to make it to 10 trillion dollars of debt without it breaking down. So far, so good, but this can't go on forever. Obama's plans call for adding another 5 trillion of debt in the next four years. Will that be too much, and break the system?

I hadn't thought of the Fed itself being the purchaser of the securities, though, so I guess we can just print money.

Meanwhile, right now if I'm looking for something to do with my spare money and I decide to buy bonds I can choose between government and corporate bonds. With the government issuing more and more bonds, that means less and less available for private sector lending. It would seem that such a policy would have a rather destimulative effect on the economy.

It just seems to me that the current economic crisis was created largely because a bunch of idiots assumed that housing prices always went up. No matter how expensive they were now, people would be willing to borrow even more next year for the same stuff. That assumption turned out to be wrong. What a surprise.

When it comes to deficit spending, it seems to me that the assumption is that there will always be a lender available to finance it. I don't know if 1.75 trillion is enough to prove that assumption wrong, but I know that there is a limit. Sooner or later, the collective lending power of the world will say, "No thanks." Does anyone have a clue what that limit is?

 

[TriangleMan]

To whom? Who has that kind of money? At least, who has the kind of money that they are willing to lend to the US government? What if they held a bond auction and nobody came?

Don't underestimate just how much wealth is out there and invested in government securities. Look at the financial statements of any major insurance company and you should see significant investments in US government securities.

In some countries have a lot of money to invest. The Sovereign wealth fund of the emirate of Abu Dhabi was at one point estimated to be as large as $975 billion. And that's just one emirate of one country (albeit a really, really rich one)

When it comes to deficit spending, it seems to me that the assumption is that there will always be a lender available to finance it. I don't know if 1.75 trillion is enough to prove that assumption wrong, but I know that there is a limit. Sooner or later, the collective lending power of the world will say, "No thanks." Does anyone have a clue what that limit is?

I'm not sure if it is quite that simple, all the government would have to do is increase the interest rate on the bonds and they would become more attractive. If the US Government right now wanted to offer 10-year bonds at 9% interest they could probably sell $10 trillion of them if they wanted to (of course the interest on that debt would be crippling but that is another issue . . .)

 

[Francesca R]

To whom? Who has that kind of money? At least, who has the kind of money that they are willing to lend to the US government?

Already answered.

What if they held a bond auction and nobody came?

It doesn't work that way. There are a number of primary dealers who, due to their status as a primary dealer, are required to bid at these auctions. Now conceivably they could all disappear and replacements not be found, but when that looks likely you'll hear about it on the news. If primary dealers have difficulty selling on US government bonds to the public, then the yields back up and/or the dollar goes down. Neither of these are particularly in evidence at the moment, although yields are higher than the low levels reached at the start of this year.

Built into the call for huge deficit spending is the belief that there will always be people (or institutions) to buy the bonds.

Yes.

At some point, that assumption will not be true.

When's that? It might not always be true but it could always be true.

Where does that assumption break down? We managed to make it to 10 trillion dollars of debt without it breaking down. So far, so good, but this can't go on forever.

Correct, it can't. But it would be an extraordinary supposition to suppose that economic activity will be contracting permanently too.

Obama's plans call for adding another 5 trillion of debt in the next four years. Will that be too much, and break the system?

Probably not.

Meanwhile, right now if I'm looking for something to do with my spare money and I decide to buy bonds I can choose between government and corporate bonds. With the government issuing more and more bonds, that means less and less available for private sector lending. It would seem that such a policy would have a rather destimulative effect on the economy.

Sort of true but the wrong way around. It is a reaction to a voluntary mass-reduction in willingness to lend to the private sector that motivated the government to (borrow and) lend to the private sector itself. The credit crash happened before the bailouts, remember? And it is a reaction to a voluntary mass reduction in willingness of the private sector to spend that motivates the government to (borrow and) spend itself instead--that is--the recession began before the stimulus packages.

When it comes to deficit spending, it seems to me that the assumption is that there will always be a lender available to finance it. I don't know if 1.75 trillion is enough to prove that assumption wrong, but I know that there is a limit. Sooner or later, the collective lending power of the world will say, "No thanks." Does anyone have a clue what that limit is?

No it might be neither "sooner" nor "later" but "never", and "never" is, in my view, by far the most likely outcome even though it is not certain. But that's just me. Although the wisdom of crowds is fallable, as you pointed out with the housing boom and crash, it usuallly isn't, and you can observe the consensus view on how "close to the limit" things are from the markets themselves--namely the nominal yield on government bonds, the real yield on TIPS and the associated break-even inflation rate, the level of the dollar against other currencies, and the spread of credit default swaps on US government debt (though these include a counterparty-risk* element so are not pure). These measures cover the possible outcomes of "breaking the limit": rapid inflation, a funding crisis (debt trap) and outright sovereign default. At this stage nothing is flashing red or even yellow.

*I remain slightly flummoxed myself on the idea of counterparty risk with swap contracts on something as serious as a US government default--it is hard to imagine that a US default would not have some rather significant effects on every large bank. And there's not much point in paying money to protect yourself from a default if that default would bankrupt your counterparty anyway and leave you with no money.

 

[paiute]

Certainly an aside, perhaps offtopic as well

Already answered.

Francesca, I just want to take a moment to thank you for all the effort you put into your posts. Whenever there is a thread on complex and confusing monetary/financial issues, I can always count on you to make them more clear.

 

[soylent]

To whom? Who has that kind of money?

It's not any one person or any one entity.

It could be deleveraging banks, it could be companies that are cutting back on spending because they want to hold some liquid assets in case they can't lend as much as they want(it's highly impractical to fill a room with federal reserve notes, there's no FDIC insurance if you put that much money into a bank account), it could be the people who got royally screwed by CDOs and MBSs and the rampant dishonesty in that business and are now refusing to touch anything that looks like consumer debt, it could be private investors who can't find any other good-looking investments and just want to stuff money into the matress in the most convenient way, it could be foreign governments that still manage to have a surplus, it could be pension funds; lots of people want to buy treasury securities at the moment.

 

[oggiesnr]

If the regulators insist on a more risk adverse capital profile for the banks then they'll be looking for somewhere to park that money. The return may not be spectacular but it'll keep the regulators happy and give them a bit more leeway with some of their funds.

Steve

 

[Meadmaker]

Already answered.

It doesn't work that way. There are a number of primary dealers who, due to their status as a primary dealer, are required to bid at these auctions.

But they aren't required to bid much. That's the scenario as the price goes down.

Now, let's follow that through. The price going down doesn't just affect the price of those securities being auctioned at that moment. It lowers bond prices in general. Bonds are held as assets at a lot of financial institutions. They are priced at marked value. Now, market value is less, therefore, those institutions have less assets. I think we've had a case recently where assets suddenly vanished off the books due to devaluation. The results weren't pretty.

I'll accept your judgement that 1.75 trillion per year isn't enough to cause big problems that trigger those bad scenarios. However, I remain somewhat concerned. It seems to me that the mental model people have of deficit spending is that government borrows from an inexhaustible pool of credit. Borrowing 1.75 trillion or 1 trillion or 5 trillion in this model is all the same, and has no impact on anything other than future US budgets.

I don't know the numbers, but I do know that the model is wrong. There is some point at which borrowing becomes much more expensive simply because there are no lenders willing to lend as much as you want to borrow. As government borrowing becomes more expesive, but government continues to borrow anyway, it restricts the ability of corporations to raise capital, and it lowers the value of existing assets. Or, it causes inflation as "new money" floods the market. I would be more comfortable if I could read someone, anywhere, saying, "Our calculations show that there will be no significant impact on the broader bond market unless borrowing exceeds 5.6 trillion dollars per year." If I were to read that, I would know that someone has at least considerered the problem.

At the moment, you say that nothing's flashing red or yellow. Excellent. I think. Unfortunately, the housing market wasn't flashing red or yellow in 2006. All the financial indicators were that everything was all rosy. Credit default swaps on mortgage backed securities were really cheap. Unfortunately, not many people paid attention to the fact that people couldn't actually pay all of that money. Likewise, I have to wonder if anyone has paid attention to whether or not there are lenders willing to lend all that money to Uncle Sam. (Not to mention other governments who, like the US, are also borrowing large quantities of money.)

 

[drkitten]

I'll accept your judgement that 1.75 trillion per year isn't enough to cause big problems that trigger those bad scenarios. However, I remain somewhat concerned. It seems to me that the mental model people have of deficit spending is that government borrows from an inexhaustible pool of credit. Borrowing 1.75 trillion or 1 trillion or 5 trillion in this model is all the same, and has no impact on anything other than future US budgets.

Perhaps the people you hang out with have that model. I don't know.

Most of the people I hang out with have exactly the opposite model; they think that deficit spending automatically increases the money supply, not realizing that if I take dollars out of Citibank stock and use them to buy T-bonds, the money supply remains the same.

And, of course, any increase in the money supply, especially on a massive scale, risks inflation, which impacts everything.

I don't know the numbers, but I do know that the model is wrong. There is some point at which borrowing becomes much more expensive simply because there are no lenders willing to lend as much as you want to borrow. As government borrowing becomes more expesive, but government continues to borrow anyway, it restricts the ability of corporations to raise capital, and it lowers the value of existing assets. Or, it causes inflation as "new money" floods the market.

Exactly. Except that it won't happen as long as people are just shifting money around instead of forcing the Fed to create a new supply.