US Abuses its "Exorbitant Privilege"

Exactly one month ago, The New York Times ran a front-page headline, “Wave of Debt Payments Facing US Government,” and punctuated the point of the accompanying story with the chart below:

Public Debt Obligations

The following day, we tipped our hat to the Grey Lady and re-produced the chart for the benefit of all Daily Reckoning readers who do not also read The New York Times. We also highlighted some of the disturbing New Math that this chart implied. Specifically, we reported, “The government will have to cough up $1.6 trillion just by the end of March. Ten years from now, the mere cost of servicing the debt is expected to reach $700 billion annually, more than three times the current burden.”

Do we mind being scooped by The New York Times? Hardly. To the contrary, we’re happy for a little company out here on the fringes of financial journalism. We’re happy that someone else has bothered to report the obvious: The US government’s finances aren’t great.

An accompanying thought, and one that The New York Times declined to mention, is this: Something that cannot last forever will not last forever.

Nevertheless, it seems like forever that the US has enjoyed what Charles de Gaulle’s economic advisor, Jacques Rueff, called the “exorbitant privilege” of printing the dollars with which it satisfies its debts. Over the years, America has maximized – nay, abused – that privilege by amassing a balance sheet so laden with liabilities that repayment has become an utter impossibility (without the benefit of a printing press).

That America’s precarious financial condition continues to dance on the sharp end of pin is a marvel of modern macroeconomics. Even after deconstructing the whys and wherefores of this marvel, it becomes no less marvelous. Essentially, America borrows and spends as much as it wishes by issuing as many Treasury bills, notes and bonds as it wishes. Somehow, no matter how many commas and zeros the US Treasury uses to quantify its auctions, the central banks of China, Japan, Russia and others continue to raise their paddles…no matter how miserably the dollar behaves.

Can this bizarre multinational financial arrangement continue forever? The obvious answer would be “no.” Nevertheless, this arrangement continues to operate without incident. For more than a decade, the largest central banks and sovereign wealth funds around the globe have been steadily increasing their holdings of US Treasury securities. Sure, some of these buyers – notably the Chinese – gripe publicly about the frailty of the US dollar, and yet, these buyers continue to buy…sort of.

As the chart below illustrates, foreign central banks have been ramping up their holdings of T-bills, as opposed to long-dated securities.

Short Term Yield Increase

In other words, foreign central banks, as a group, have been rolling off their long-dated holdings and parking their dollars in T-bills, despite the fact that T-bills yield almost nothing. Hmmm, why would they do that, we wonder? Are the buyers worried that inflation will kick up in the US? Probably. Are the buyers also worried about committing their capital to the US for a long time? Probably.

Whatever the exact motives that inspire these Treasury buyers to buy fewer long-dated Treasurys, we wonder how motivated they will be to refinance $1.6 trillion of maturing T-bills during the next three months, and $2.5 trillion during the next 12 months (in addition to fresh borrowing!).

“The faith-based, dollar-dependent monetary system is like a loaded pistol in front of a depressed man,” Bill Bonner remarked one year ago. “It is too easy for the US to end its financial troubles, Rueff pointed out, just by printing more dollars. Eventually, he predicted, this ‘exorbitant privilege’ will be ‘suicidal’ for Western economies.”

Hmmm…maybe it’s time to step out of the line of fire.