Investment sage Warren Buffett last month warned his shareholders that the country, still reeling from the collapse of the housing boom, faced a bubble in Treasury bonds.
“When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s,” he wrote. “But the U.S. Treasury bond bubble . . . may be regarded as almost equally extraordinary.”
Buffett’s comments came before the Federal Reserve last week said it would buy $300 billion in long-term U.S. Treasury debt over the next six months.
The government also lifted the ceiling on mortgage-backed securities that Fannie Mae and Freddie Mac can guarantee, up from $500 billion to $1.25 trillion. And the Fed doubled to $200 billion what it might purchase of that debt.
“Never in the U.S. have we had this level of money creation in a short period of time,” said Olivier Garret, chief executive of Casey Research in Stowe, Vt. “The scale is such that you could see the printing presses turning red hot.”
Interest rates fell sharply and stock markets responded positively to the Fed moves. But critics argue the actions will devalue the U.S. dollar, reduce confidence of foreign buyers and stoke inflation.
“The U.S. dollar is . . . not backed up by anything, only by the fact that the world has confidence the U.S. will be honoring its debts,” Garret said.
The cost of insuring against U.S. government default has risen several-fold in recent weeks. Foreign investors have more than $2.5 trillion of U.S. government-backed debt coming due this year and they might not be inclined to renew.
Combined with more than $2 trillion in deficit spending, critics argue the country is on a crash course with inflation — possibly hyper-inflation.
In the long term, the Fed plan risks inflation, but the problem facing the country is deflation, or falling prices, said Jon Zeschin, president of Essential Advisers in Denver.
The lack of credit, the increase in personal savings and the sharp decline in economic activity are all deflationary.
While the Fed knows how to tame inflation, it has almost no tools to contain falling prices once they set in, said Michael Englund, chief economist with Action Economics in Boulder.
The risk of inflation doesn’t come from the Fed buying government debt, Englund said, but from new debt coming to market via deficit spending.
The Treasury’s purchases represent only a fraction of the total government debt — assets that can be sold, Englund said.
The payoff from deficit spending is much less certain.
As to “huffing and puffing” by foreign governments about not investing in U.S. debt, Englund counters that no other country runs trade and budget deficits large enough to support a global reserve currency.
If debt purchases and other stimulus efforts stave off deflation, the Fed will face an immediate challenge: removing the money pumped into the economy without choking off the recovery, Englund said.
The problem is that no one rings a bell when the recession ends, and political pressures will be intense to keep interest rates low, he warns.
If the Fed moves too slowly to pop the Treasury bubble when necessary, inflation could flare.
Kansas City Federal Reserve Bank president Tom Hoenig recently told Dow Jones the stimulus will need to be unwound without excuses or hesitation.
“I think we risk a very serious inflationary problem with new bubbles that could be created, new risks, new dangers that are created around that,” he said.
Aldo Svaldi: 303-954-1410 or asvaldi@denverpost.com
