NRO’s eye on debt and deficits . . . by Kevin D. Williamson.

Is the U.S. Treasury the Scene of the Next Bubble to Burst?


Daniel Gross, he of “bubbles are good for the economy!” fame, says not to worry about a possible bubble in U.S. Treasury bonds.


Treasury bonds, Gross’s argument goes, are one classy class of asset — not like the snake-oil securities that often indicate the presence of bubbles in other markets. It’s not a bubble, he says, just “frothy.”

First, one of the features about bubbles is that, toward the end of them, the people selling assets—shares in telegraph companies in the 1840s, railroad bonds in the 1880s, dotcom stocks in the 1990s, Miami condos in 2006 — are hawking pipedreams and fantasies. They’re making financial promises that can’t be fulfilled, or that simply don’t add up. When reality finally catches up with the hype, the crash can wipe out some investments entirely and the bubble-prone sector can slump 70 percent or more. But that’s not what is happening in the government bond market. The people selling Treasury bonds—that is, the U.S. government — are making extremely modest promises and have a long record of living up to much more extravagant promises. On Monday, Aug. 30, according to the Wall Street Journal, Treasury will sell $30 billion in 13-week bills and $30 billion in 26-week bills. I’d be willing to wager my next paycheck that those bonds will perform exactly as advertised: Buy those bonds and hold onto them, and you’ll get your principal back plus a bit of interest in a few months. In the interim, the market value of those bonds may rise and fall. But they won’t double, and they won’t go to zero.

That’s what passes for bullishness on U.S. debt these days. Okey-dokey. It’s worth noting that those Miami condos and dot-com stocks looked like good investments to a lot of smart people — and our real-estate regime sounded  like a good idea at the time, and Iraq was chock full of WMD all the smart guys said — and we could very well find ourselves saying the same thing about Treasuries in the near future: What in hell were we thinking? Surprises happen.

How much foam is there on top of this fiscal frappe? Treasury bond yields are down about 40 percent in the past six months, as Gross also notes — a frothy market indeed. But I do not think Gross is showing much guts in his proposed wager: True, the U.S. government probably is not going to default on its debt in the near future. (Probably.) And, sure, he’s right that the values of the bonds will fluctuate but “won’t double, and they won’t go to zero.” But here’s the thing: They don’t  have to. The government doesn’t have to default, and the value of the bonds doesn’t have to double or go to zero to cause all sorts of havoc in U.S. finances. Interest rates are very, very low — but even as low as they are, we’re still piling on debt so quickly that any serious uptick in the government’s cost of borrowing — and no, it does not have to double — could send us into a Greek-style fiscal crisis, especially if it should coincide with, say, the second and even more painful decline in a double-dip recession. Or a financial shock caused by an international crisis in, oh, Iran. Those are the kinds of risks that the Leviathan-on-a-leash guys never really account for: “Oh, everything will be fine, so long as everything is fine.”

And Treasuries are only one part of a larger and inherently interconnected government-debt market. You start to look at the shenanigans going on at the state and local levels — shenanigans that could end up resulting in federal bailouts for the states and union-goon pension funds, putting those obligations on the federal books — and there’s ample cause for insomniac nail-gnawing. I’ve been writing about those Build America Bonds — the financial instrument by which Uncle Sam bribes states to go even deeper into debt by subsidizing the interest on construction bonds. President Obama’s political home state of Illinois has been pushing a whole bunch of those bad boys out into the marketplace (which has received them enthusiastically — contrarians take note) even as it looks desperately for other sources of borrowing to meet its various obligations, which includes a pension-funding shortfall that is the worst in the nation.

Interesting thing about those Illinois Build America Bonds, or BABs:

[Bond-fund manager Craig] Brandon points to an A1-rated state of Illinois BAB issued last week with a yield of 7.11% and a maturity date of 2035. By comparison, an Abbot Labs corporate bond due in 2039 and trading in the secondary market has the same rating but a yield of just 5.16%.

Translation: Even though Illinois’s credit score is comparable to Abbot Labs’ credit score, and even though Illinois is a state, with all the power that implies, it has to pay more to borrow money. Why? Because the markets do not really believe that A1 rating. Always remember the case of Enron: Its share price had declined more than 80 percent before the credit-raters ever got around to downgrading it. Listen to the markets.

But the risks with which U.S. public finance is shot through are tied up in more than simple bond ratings: Sovereign investors, such as our friends the ChiComms, aren’t waiting around to hear what Moody’s has to say about things. They have their own incentives, which are different from Bond Trader Joe’s.


China reduced its holdings of U.S. Treasury debt for a second straight month in June while the holdings of Japan and Britain rose.

China’s holdings fell by $24 billion to $843.7 billion, a decline of 2.7 percent, the Treasury Department said Monday in a monthly report on debt holdings.

Total foreign holdings of Treasury securities rose $45.6 billion to a total of $4 trillion, an increase of 1.2 percent.

The debt figures are being closely watched at a time when the U.S. government is running up record annual deficits. A drop in foreign demand would lead to higher interest rates in the United States. The yield on Treasuries rises when fewer people invest in them.

It would start with the U.S. government paying more interest on its $13.3 trillion national debt and then ripple through the economy. Consumer loans such as home mortgages and auto loans track the yields on Treasurys, so they could rise, too.

Say what you like about the aged autocrats in Beijing, they know how to count. And they are worried about the dollar. In that, they are not alone.

Leading up to that much-awaited Bernanke speech, the dollar was feeling a little Chinese pressure, too:

“Onshore banks are selling dollars because the dollar is a net risk position for them given the uncertainty over Bernanke’s remarks and revised second-quarter U.S. GDP data tonight,” said a Shanghai-based trader at a foreign bank.

The thing about our Chinese creditors is this: Governments make calculations along nonfinancial lines. Profit and loss is not the end of the game for Beijing — or for central banks and governments in other countries. We are taking risks that are very difficult to calculate, because they are political as well as economic. Mr. Gross may be right: Maybe we will come through this without a hiccup. But going out on the ledge of the Empire State Building is still a stupid and risky thing to do, even if you do not, in the end, fall. We should get off the ledge.

– Kevin D. Williamson is deputy managing editor of National Review.


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