Starving the World of Money

Two days ago, blogging friend Tim Eisele left this comment on a short post of mine about the Germans having a failed debt auction.

This is related to something that's been bugging me ever since I saw that "Quantitiative Easing" video you posted a while back. It basically said that the banks were afraid to lend money normally, so instead they were buying Treasury bonds - loaning their money to the government instead of to people and businesses who could actually use it.

This made me think, "Doesn't this mean that the problem isn't that other investments are too risky, but that the government has made Treasuries too attractive?" The obvious solution isn't to pump in more money, but to make Treasuries a less attractive invesment.

I kind of suspect that a significant part of our troubles right now, is that the government has been borrowing too much all along, and have already sucked up all the funds available for loaning. They have been trying to use this money for "stimulus", but Treasuries are *still* too attractive, and the banks just use the stimulus money to buy *more* Treasuries. Now that all the air has been sucked out of the business loans, goverments are going to be competing to steal loan money from *each other*.

I totally agree with Tim. I thought I'd reply to it in a blog post since it goes into something I've wanted to explore anyway.

The problem is not just the rate of return on Treasuries.  It's also the fact that there are so much of them to buy.  In an environment where business investments all look like losers, anything that will keep the banks' money safe will be seen as a good investment, even if it returns nothing.  The government has been trying to lower the returns on Treasuries in the hopes of forcing banks to lend, but until Treasuries leap off the computer screen and start beating you with a stick, they'll be more attractive than, say, loaning money to ALCOA.

The mammoth stimulus package that Obama is considering is going to make matters much, much worse.  All of that money has to be borrowed.  It's borrowed by auctioning off government debt.  As we've seen, government debt at any price is better than any commercial investment right now.  In an attempt to revive the economy, Obama is going to starve it of funds.  Remember, all jobs come from profits.  It can't possibly work.

It gets worse.

Everyone around the world, with the exceptions of Germany and Australia, are doing the same thing.  The Germans, in a fit of Prussian stubbornness and the Aussies in typical Aussie self-reliance, are pushing very modest stimulus packages.  Everyone else is going bananas with their checkbooks. From what I've read, government borrowing across the globe will triple this year.  There will be no lack of government securities to compete with commercial firms who live on borrowed money.

Example: a plumbing subcontractor waits to get paid by the general contractor who waits to get paid by you who waits to pay until the remodel is finished.  Between now and when your new kitchen remodel is done, the plumber lives off of borrowed money.  It's not a violation of Dave Ramsey's principles, it's the way the business works.

Back to the world.  Greece is a financial basket case.  They need to borrow money to keep afloat.  What will it take to get you to buy Greek bonds when German bonds are available? The Germans just had a failed auction and might now have to raise their interest rates in order to attract money because money is rushing into US bonds.  Once the US goes on its mad spending spree, lots and lots and lots of money will rush into US bonds and the rest of the world will either have to keep raising rates or simply default on its payments. What does this mean for Greece?

Greece has to outbid Germany who has to outbid the US.  The US (for now) can just sit there and issue debt and watch it get snarfed up because we're the ultimate safe haven.

Commercial firms will have to outbid the US, too.  Good luck with that.

The solution: Suck it up.  Stop borrowing and spending.  Accept mammoth unemployment and bread lines.  You aren't going to escape it no matter what you do.  You can only postpone it.  Postponing it will make it worse when it finally happens.

About three years ago, right about the time I started this blog, I went through some very tough times.  I had to save money for 6 weeks in order to be able to afford to take a load of rubbish to the dump.  That cost $15.  I shopped at thrift stores and estate sales.  I paid down my debts and now I can afford a Nikon D60 and a Sony AVCHD Handycam.  Had I continued to borrow and spend, I'd be in far worse shape now.

There is no discontinuity as a function of size.  That is, what works at the micro layer works at the macro layer as well.  At no point does the world turn upside down and entities smaller than some size must pay off their debts, but entities larger than some size can borrow to infinity.

Things to watch: Eventually, the world's appetite for Treasuries will wane.  Our big investors, China and Japan, are contracting, too.  Even if they wanted to spend all their money buying Treasuries, they're going to have less money to do it.  If you want to track the decline of Treasuries, watch TBT.  TBT shorts Treasuries.  That is, if the US debt auctions go well, TBT goes down.  If the world slows down it's purchase of Treasuries, TBT goes up.

Update: Check out this comment over at Across the Curve. It's a fantastic summary of the situation.