How are we going to fund this debt?

The funding of the Treasury debt is going to be one of the most important capital market issues for Treasury. Of course, the TARP will be more important in the short-run, but how debt is funded will impact debt markets for years. The Treasury Borrowing Advisory Committee provides a good insight for what is in store for the next few years. The answer is somewhat obvious, bigger auctions and more of them to fill all maturities.

Some key highlights:

• The funding may be $3-$4 trillion in in 2009-2010 period.
• Market saturation is going to be a problem. There is $150 billion of FDIC issued paper that has been issued.
• 55% of the debt is held by foreigners up from a 1/3 only a few years ago.
• There are only 17 primary dealer down from 30 just a decade ago.

There was little talk in the minutes about the saturation issue which may be the most important. We will have to have more discussion on the old issue of crowding out.

Smart thinking by Obama on trade issues

The House bill called for all sorts of spending plans but also had clauses to "buy American" goods for the purchase of materials. This may make sense in a isolated world and if the goods cost the same. We will use taxpayer dollars to purchase goods from US firms in order to increase the multiplier effect. However, we live in an integrated world where there are ramifications from our actions. The level of world trade is at all time highs and the overall benefit of lower priced goods for consumers is significant.

The EU has responded that this "buy American" provision smacks of protectionism and would result in sanctions. This is exactly what we do not want to have when we are in a global recession. This would be similar to the Smoot-Hartley tariff issue which plunged world trade into a dramatic decline.

The response by the President was positive. “I agree that we can’t send a protectionist message,” he said in an interview with Fox TV. “I want to see what kind of language we can work on this issue. I think it would be a mistake, though, at a time when worldwide trade is declining, for us to start sending a message that somehow we’re just looking after ourselves and not concerned with world trade.”


We hope that Congress gets the message.

BOJ equity purchase plan - is this the role of the lender of last resort?

There is credit easing which is the name used by the Fed to describe their programs of purchasing debt in exchange for cash. There is quantitative easing used by the Japanese to boost their economy last decade. Now we have again equity easing where a central bank will purchase equity holding of banks to liquefy balance sheets.

This is very different than other plans to purchase high quality credits or lend against high quality debt. This is taking a position on the residual value of a firm. The last in the capital structure to be paid. This is also not a program of providing fund to add liquidity. It is a simple task of taking risk off the balance sheet of banks. This is not the first time the BOJ has undertaken this program, but it sets an interesting precedent to purchase stocks every time the banks need help with their balance sheet. Now the Japanese banking system is different than others with these large stock holdings but it is an extreme with central banks. This give us an idea of the extremes that may be taken by central banks.

Upon government approval, the central bank will buy 1 trillion yen, or US$11.2 billion, in shares until April 2010.It will not offload shares to stock markets until the end of March 2012, the BOJ said after the policy board met earlier in the day.The Bank of Japan offered a similar but bigger stock purchase program between November 2002 and September 2004 when it bought a total of 201.8 billion yen in shares.The bank began selling the stock a year later but suspended the sales in October 2008 after the failure of U.S. investment bank Lehman Brothers Holdings Inc. triggered massive declines in global equity markets. The central bank held 1.27 trillion yen in stocks as of the end of September. -Associated Press

The Nikkei popped on the announcement and then sold off. It was higher yesterday but still below the initial increase in the index. The market seems to think that this is not a positive signal in a difficult environment. The Nikkei is down nine percent since the beginning of the year.

What did we learn from Davos in 2009? Deficits matter to some

The Davos meetings have to some degree become irrelevant during this current crisis. The titans of global banking no longer exist and policy-makers have to focus at home on trying to solve economic problems. There is no money for big think projects and no one has been able to cut-through the crisis to provide a useful solution. There is a call for regulation but there does n0t seem to be good solutions from the internationalists. There was not even a good defense of globalization and trade.

What was noticeable was the focus on what the impact of budget deficits will have the global financial markets. While there is no concerns about whether deficits matter in the US Congress, some emerging market leaders are asking whether there will be crowding out from the US deficit. Fro example, former Mexican president Ernesto Zedillo is asking the question of how the US will pay for the stimulus. He states, "People are not stupid. They see the huge deficit, the huge spending, and wonder what cones next."

The argument is a corollary of the global imbalance story. Because the US has such a well developed capital market, it has been a safe haven for foreign investors. US has been able to continue current account deficits with the savings from the rest of the word because of this strong financial system. Now this same system is in overdrive and is asking the rest of the world to finance what may be close to $2 trillion in 2009. Developed countries that do not have as well established bond markets will not be able to compete against the US for their funding needs to there will be crowding out of deficit financing by other countries.

W will not go into the arguments on the instability of this process, but suggest that the crowding out story is real in the short-run. The natural question from the creditor's point of view is whether they are getting a good investment. The savings countries which include many in the developing works are now asking the question of whether the stimulus is prudent given that they will have to pay for the projects.

What happens if the world balks at buying the debt?