I wrote last month how a typical Japanese investor that had purchased a Two-Year Treasury Note lost more than 10 percent per year on their investment – see post from September 27th— and that the only way they would keep coming back and buying U.S. Treasury instruments would be an increase (eventually) in interest rates. Since then at the 17 economic forecast presentations I have given, the issue of rising rates seems to be most contemptuous by the audience. Simply stated, they believe that with no demand for money rates should not rise.
My response is that there is massive demand for money—but not in the typical avenues of home purchases, autos and other durable goods—and that is in record federal deficit financing and corresponding record- trade deficits. Just look at the article link from the Wall Street Journal on Friday. The August trade deficit approached $50 billion ($46.3 billion to be exact) of which $28 billion was with China (and the $28 billion was an all-time record). Wow. Add that to a massive Federal deficit in this past fiscal year of $1.3 trillion in 2010 and an a projection of $1.1 trillion in 2011 (that’s the off-budget surplus which reduces the deficit by estimated excess Social Security cash flows—with the 2011 on-budget deficit of $1.154 trillion) and you are looking at almost a couple of trillion of equivalent borrowing. Massive.
Looking at it another way, just contrast the Federal deficit of 2009 through 2011 to total commercial real estate lending in place and total first-lien residential loans in place. Fannie Mae estimates that as of 2010 first-lien residential lending outstanding is $9.6 trillion and other sources tally total commercial real estate lending at $3.5 trillion. Total Federal deficits in 2009, 2010 and 2011 are estimated to be $1.4 trillion, $1.3 trillion and $1.1 trillion, respectively, for a total of $3.8 trillion. That means that in just a 36 month period, the Federal government borrowed more money than all of the total commercial real estate loans outstanding. When comparing residential lending, that equates to 40 percent of the amount of the total first-lien lending outstanding on U.S. homes. Now you see that there is significant demand for borrowing.
Now throw in the inflation data contained in the linked Wall Street Journal article, and you might start being a believer in rising rates. Wholesale prices in the past three months jumped 1 percent (and yes—that includes energy and food, but unless you do not eat nor use any energy then that remains the appropriate factor) which annualizes to a potential 4 percent annual wholesale inflation rate.
The Fed released on Friday their expectations on inflation, but do not be surprised if they respond by stating they are going to increase the money supply by printing more money—which in the long run will be inflationary.
And that is my two cents. Or with inflation 2.08 cents………..
Trade Gap in U.S. Widened in August– WSJ artcile