When you and I want to spend money we don’t have, we use a credit card, we borrow it from a bank – good luck with that – or we do without.
[img]433|exact|||no_popup[/img]
When the government wants to spend money it doesn’t have, it sells bonds.
The American tradition of selling bonds to raise money dates back to the days when an upstart group of colonists sought to throw off the yoke of British tyranny. Without Revolutionary War bonds, Washington and his ragtag militia wouldn’t have had the money to buy the muskets they needed to defeat the redcoats.
At every turn in American history, from World War I to the dark months following 9/11 when the U.S. issued Patriot Bonds, selling bonds has been a critical governmental apparatus for raising money.
But, like any other debt mechanism, someone has to buy what you are selling.
It Always Worked Before, but…
After the failure of a British bond auction yesterday, and the cool reception of a similar sale held at the same time in Washington, the notion of selling bonds to raise the money needed by the government to stimulate our flagging economy has been severely undermined.
Yesterday’s botched bond auction in Britain was the first failure of its kind in more than seven years.
The fact that the U.K. auction fizzled, may explain the weaker-than-usual demand for the sale of $34 billion worth of U.S. Treasury securities yesterday. Potential investors simply may be spooked. By comparison to the U.S. auction, the British sale was relative small, involving only $2.55 billion worth of 40-year “gilt” bonds.
In part, the smaller demand for U.S. securities yesterday may mirror concerns that the government is taking on a huge amount of debt to finance its economic stimulus programs and the rescue of the nation's largest banks. Given the shaky state of the American economy, potential buyers of U.S. debt may be anxious about the depth of liability the government plans to take on over the next several years.
U.S. Going Too Far Too Fast?
According to news reports from yesterday’s Treasury auction, there also were fewer foreign bidders at the table. At a similar auction in February, foreign bidders, like the Chinese, comprised approximately 49 percent of the bidders compared to yesterday where the off-shore participants only numbered about 30 percent.
The paucity of foreign buyers may be indicative of a growing worry that the U.S. government may be getting in over its head. If foreign bidders stop buying what we’re selling, then the ability of the government to raise money may be stopped in its tracks.
This investor apprehension has not been restricted to the British and American bond markets only. Other G-20 nations like Germany and Japan, who are engaged in similar governmental spending programs to stimulate their economies, have experienced comparable problems.
The recent upswing in the stock market may also explain the stunted appetite at yesterday’s Treasury auction. The weaker demand could have resulted from the fact that the sale was held at the same time as a similar auction for $7.5 billion of long-term government bonds at the Federal Reserve. Moreover, because of the growing risk, investors also may be looking for higher yields on the bonds than the government is willing to give.
With all of these factors in the mix, investors will be watching very closely the results of today’s auction of $24 billion in seven-year bonds.
Either way, the idea that bonds are a sure solution to paying our way out of this recession no longer may be an assumption upon which the government and this administration can rely.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
