Greece's Crisis: A Warning To Profligate U.S.?
2010 marks the beginning of the second year of the Federal Reserve's zero-interest-rate policy, and there is growing concern from many quarters that it is creating excessive global dollar liquidity. Just two months ago, the Chinese government accused the Federal Reserve of fueling "a huge carry trade" that was having a "massive impact on global asset prices."
The nascent recovery would surely stumble if we had a recurrence of another credit and insolvency crisis similar to what led to the economic meltdown of 2008 and 2009. The fact that the Fed's current zero-interest-rate policy has exceeded the 12 months of 1% interest rates in 2003 and 2004, which contributed to that asset inflation and collapse - from which we are still recovering - suggests the need for heightened vigilance about some kind of replay.
The Fed's record of heading off inflation and asset bubbles while also supporting economic and employment stability by timely manipulation of the money supply is not particularly good. But even if the Fed can avoid a double-dip recession through deft monetary policy moves, sound fiscal policies are needed to strengthen the economy's foundation, providing confidence and incentives for private-sector expansion and job creation.
The Congressional Budget Office predicts that ongoing annual budget deficits will drive the federal debt to almost $19 trillion by 2015 - a near-doubling from 2008, when government debt broke through $10 trillion because of the TARP rescue. Such debt growth, if inflationary, erodes domestic savings and weakens the dollar as the global reserve currency.
But more serious risks would also emerge. A sudden increase in borrowing costs on a rapidly growing debt burden could trigger a crisis in confidence, sharp dollar devaluation and a resultant stealth default on long-term U.S. Treasury bonds.
A shocking thought for sure, but given the recent panic over deficit spending in Greece, which precipitated a doubling in sovereign debt rates in a matter of months, it is important to understand the dynamics that could precipitate a similar crisis here at home.
U.S. Treasury management has overemphasized the issuance of short-term over long-term debt. Currently, there are 2.5 times more Treasury bills issued than 10-year notes and 30-year bonds.
In the current Fed-engineered zero-interest-rate environment, the annual interest cost of T-bill debt now averages about one-quarter of 1%, while 30-year Treasury bonds cost about 4.55% annually. The average interest rate of all outstanding Treasury debt was about 2.55% at the end of 2009, as compared with nearly 5% during much of 2007 and 6.5% at the end of the previous business cycle 10 years ago.
The Fed will eventually normalize interest rates, which would take the government's borrowing cost up at least twofold. A crisis in confidence, however, could abruptly lead to much higher borrowing costs.
The trigger for the sovereign debt crisis that drove up borrowing costs in Greece by more than 100% in the last three months was primarily tied to its government deficit exceeding 12% of GDP. The expected $1.6 trillion Obama budget deficit for the upcoming year is approximately 11% of projected U.S. GDP.
When the $1.6 trillion budget deficit is added to the $2 trillion of U.S. debt scheduled to roll over this year, the Treasury faces the need to place more than $3.5 trillion in debt in 2010, a record amount equal to nearly 25% of GDP.
Where will the money come from at a time when our three largest foreign creditors - China, Japan and Great Britain - have no capacity or willingness to increase their holdings of U.S. Treasury debt? The Federal Reserve will be forced to monetize hundreds of billions of dollars in debt, which will raise fear of inflation and cause investors to demand higher offsetting interest rates.
The same dynamics of sudden payment hikes that forced foreclosure on nearly half a million American homes, financed with low short-term teaser rates of adjustable mortgages, can hit the U.S. government debt market. Staying on the present course of increasing our national debt and risking the rapid rise in the cost of financing that debt is the perfect storm that could precipitate a spiraling debt and devaluation crisis.
It's a cliche to say that we need change and a new kind of leadership in Washington. But with the ship of state so clearly heading in the direction of dark and threatening clouds, all hands are needed on deck to shorten the sails and change course.
The Tea Party was born only a year ago out of concern about the fiscal irresponsibility of both parties and the simple recognition that we cannot borrow, tax and spend our way to prosperity. That message led to the Tea Party's first electoral victory in Massachusetts. Now its compass is set on November.
• Powell is managing director of Alpha-Quest LLC, an alternative investment consulting firm, and a visiting fellow at Stanford University's Hoover Institution.
