Trump's Tax Cuts Forcing the Fed to Buy Up US Treasurys
by John Lawrence, November18, 2019
Republicans used to stand for fiscal conservatism. But they're only fiscally conservative when Democrats are in power. When they control the purse strings, they spend like drunken sailors with the result that the national debt is now $23 trillion. During FY2019, the federal government spent $4.45 trillion and collected approximately $3.46 trillion in tax revenue. A little simple arithmetic shows that the US Federal government has to borrow almost a trillion dollars a year in order to make ends meet or 82.5 billion dollars a month. And this will go on and only likely increase ad infinitum.
"The belief in Washington and on Wall Street has long been that the U.S. government could just keep issuing debt because people around the world are eager to buy up this safe-haven asset. But there may be a limit to how much the market wants, especially if inflation starts rising and investors prefer to ditch bonds for higher-returning stocks."
However, there is another scenario. The Federal Reserve could just keep eating the debt much as it did during the various stages of quantitative easing (QE). The Fed paid the Wall Street banks in cash for the Treasury bonds it took on its balance sheet. This cash provided the liquidity which allowed the banks to keep functioning after the Great Recession of 2008. However, the Fed promised to start selling those Treasury bonds back into the market thus unwinding its balance sheet, what you might call a quantitative tightening. But the Fed didn't get very far with that until the liquidity of the big banks started to be a problem again. So the Fed is back to QE again although now it's not calling it that. However, it is infusing $60 billion a month into the repo market, and taking that much in Treasury bonds off the Wall Street banks' books.
Wall Street banks are required to buy US Treasury bonds thus soaking up US government debt, that is if no other country or individual or other entity wants to buy it. Increasingly, it's getting difficult for the Treasury to sell its debt as other countries like China, which holds the largest amount of US debt, are cutting back on their purchases especially in light of Trump's use of the US dollar in trade wars and sanctions. US debt is not seen as the gold standard that it used to be. Therefore, the debt piles up on the balance sheets of Wall Street banks, and there is the threat of another liquidity crisis as there was in 2008. That's why the Fed is stepping in to buy up US Treasury debt and disappear it on its balance sheet thus providing liquidity to the Big Banks.
Market Watch writes:
Primary dealers are banks and other financial institutions approved to trade with the Federal Reserve. In return for that privilege, they are obligated to place bids at the U.S. Treasury Department’s debt auctions.
With the federal fiscal deficit widening, dealers have bought up an increasing amount of government debt, constraining their ability to provide liquidity to funding markets when needed, but only a small proportion of those holdings are in shorter-term Treasury bills.
U.S. Treasurys held by primary dealers stood at $206 billion in the week ending Sept. 25. This compared with their holdings of Treasury bills which averaged $22.9 billion over the last six months, according to Fed data.
So US Treasurys, largely as the result of Trump's tax cuts for the wealthy, are clogging up the system, and the Fed must step in again after it had promised to unwind its balance sheet comprising trillions of US government debt when economic times returned to normal. But what is normal these days? A lot of pundits think there will be QE, like strawberry fields, forever. That would be the new normal. But wait until there's a Democratic President, and Republicans will start screaming bloody murder again about the national debt.