‘Unsustainable Deficits’ and Bond Boycotts: Panic at the Fed or Back to Financial Normalcy?

‘Unsustainable Deficits’ and Bond Boycotts: Panic at the Fed or Back to Financial Normalcy?

by F. William Engdahl


Global Research, February 24, 2010








The decision of the US Federal Reserve to raise its key interest rate was definitely not a sign of confidence in the US economic recovery or a signal that Fed policy is slowly returning to normal as claimed. It was rather a signal of panic over the weakness in US Government bond markets, the heart of the dollar financial system.



Financial markets have reacted with jubilation, by buying dollars and selling Euros, at the decision by the Fed to raise rates for the first time since 2006 for its so-called Discount Rate, going from 0.5% to 0.75%. The Discount Rate is the interest rate charged for banks to borrow from the central bank. At the same time the Fed left its more important short-term Fed Funds rate unchanged and historically low -- between 0.0% and 0.25%. In its official statement the Board of Governors said the rate move was intended to push private banks back into the private inter-bank borrowing market and away from reliance on Federal Reserve subsidized money which had been provided since the financial crisis began in August 2007.



The decision, in plain words, was framed so as to give the impression of a ‘return to business as usual.’ At the same time, financial players like George Soros continue to speak openly about the fundamental weakness of the Euro. This has the effect of taking speculative pressure away from fundamentally worse economic and financial fundamentals within the dollar zone at the expense of the Euro. The reality is that the dollar world is anything but returning to ‘normal.’



‘Unsustainable deficits’



The conservative President of the St. Louis Federal Reserve Bank, Thomas Hoenig recently warned in a little-reported speech that if the size of the Federal Budget deficit is not dramatically and urgently reduced, public debt will soon look like that of Italy or Greece, exceeding 100% of GDP. In a recent speech Hoenig noted, “The fiscal projections for the United States are so stunning that, one way or another, reform will occur. Fiscal policy is on an unsustainable course. The US government must make adjustments in its spending and tax programs. It is that simple. If pre-emptive corrective action is not taken regarding the fiscal outlook, then the United States risks precipitating its own next crisis….”



Translated into laymen’s language, that means savage cuts in Government spending at a time when real unemployment is running in the range of an unofficial 23% of the workforce, and the states are struggling to cut their own spending, as Federal dollars disappear.



In brief, the United States economy, though no one is willing to say so, is caught in a Third World-style ‘debt trap.’ If the Government cuts the deficit, the economy sinks deeper into depression. But if it continues to print money and sell debt, buyers of US Treasury debt will at a certain point refuse to buy, meaning US interest rates could be forced severely high in the midst of depression conditions—equally catastrophic to the economy.



Bond boycott?



The second option, a boycott by buyers of US bonds, may have already begun. On February 11, the US Treasury held an auction of $16 billion worth of 30-year bonds and securities to finance its exploding deficits. In a little-reported feature of a sale which did not go well in terms of demand, foreign central banks reduced their share of purchases from a recent average of 43% of the total to a mere 28%. The largest foreign central bank buyers of US debt in recent years have been China and Japan. Secondly, it appears that the Federal Reserve itself was forced to buy the slack demand, some 24% of the total of bonds sold versus 5% only a month before.

rest at Global Research Canada