As Barack Obama takes over from George W. Bush, he may need to borrow an idea introduced by another US president viewed as an economic failure.
In the late 1970s, Jimmy Carter issued $6 billion (Rs30,000 crore today) of debt in foreign currencies such as the Deutsche mark and the Swiss franc. The move was aimed at halting a precipitous drop in the US dollar. The securities, dubbed “Carter bonds”, did little to help Carter’s legacy.
Tokyo-based economists, including Kazuo Mizuno of Mitsubishi UFJ Securities Co. Ltd, say President-elect Obama, faced with enormous and growing debt obligations, will consider selling debt in yen and other currencies. Should markets begin making room for “Obama bonds”?
Obama’s treasury department wouldn’t take such a decision lightly. After all, countries only resort to such securities out of weakness, and investors know it. It would be politically devastating for Obama to be seen emulating any of Carter’s financial policies. Carter’s tenure is synonymous with stagflation and economic malaise.
Then again, the US must be creative in financing the untold amounts of debt it will issue to stabilize banks, boost growth, pay for two costly wars and fund programmes such as Social Security. Can we really dismiss out of hand the US eventually selling foreign currency debt?
A year ago, few would have believed Lehman Brothers Holdings Inc. would fail and that Citigroup Inc. would need a government-backed rescue. Few would have expected the US government to enter into the insurance business and perhaps the automobile trade. Few would have thought the Federal Reserve would adopt the “quantitative easing” policies of the Bank of Japan (BoJ). And yet, here we are.
Soon enough, credit rating companies may wake up and begin downgrading the US government. Asian central banks will grow tired of seeing their dollar investments lose value. And the US currency may suffer more from the kind of treatment Jim Rogers intends to give it. Within the next few months, the chairman of Singapore-based Rogers Holdings plans to own no dollars at all.
Nations can’t simultaneously maintain trade and current account deficits without ample financing. If purchases of government, agency and corporate debt dry up—especially among foreign buyers—the US will find itself in a very bad way. Milton Friedman’s view that deficits are sustainable, particularly for a country that issues the reserve currency, is about to be tested as never before.
No one seriously expects the US to default on debt. Yet, issuing foreign currency-denominated treasuries could reduce the perceived risk of holding US debt.
“The US cannot finance its deficit by itself,” Mizuno told Asia Times Online last week. “The US financial system cannot survive without foreign investors. We will see Obama bonds in the future.”
These are also confusing times in Tokyo, where BoJ is faced with the prospect of cutting its 0.3% benchmark rate. Governor Masaaki Shirakawa thinks he can avoid returning rates to zero. He’s wrong, and the quicker that central bank officials realize it, the better.
The more one looks at the Fed chairman Ben Bernanke’s handiwork, the clearer it is that he’s following BoJ’s example. Fed has pumped far more stimulus into the banking system than its 1% benchmark rate would suggest. It has even moved to shore up central banks in economies such as Singapore and South Korea.
US debt managers will need to get creative, too. In 2001, Japanese lawmakers proposed issuing “Koizumi bonds”, named after former prime minister Junichiro Koizumi. If David Bowie pulled off selling bonds, why not Koizumi? Had the bonds been issued, the proceeds would have funded structural reforms and stimulus measures.
Investors who loaded up on the treasury inflation-protected securities, introduced by Bill Clinton’s administration, can’t be happy as price pressures wane. It may be time to roll out debt linked to deflation. If deflation is in the cards for the US, expect the Fed to employ even more drastic methods. Over time, all that liquidity is sure to take a toll on the dollar’s value and reduce the attractiveness of US debt.
Yen is as good a currency as any to consider. Japan’s finance industry has made a business with “samurai bonds”, yen-denominated debt sold in Japan by foreign issuers. The US government would just become Tokyo’s biggest customer.
Debt managers will inherit a record US budget deficit. The bond dealers that advise the treasury this month forecast a $988 billion shortfall for the fiscal year ending September. Treasury secretary Henry Paulson last week said the government will issue $1.5 trillion of debt.
Ballooning debt doesn’t seem like a major issue now because there’s “excess demand” for treasuries rather than excess supply, as investors flock to government debt as a haven, former treasury secretary Lawrence Summers said at a forum in Washington last week.
Yet, the next treasury team will get a crash course both in crisis management and planning for the US’ financial future. Obama bonds could indeed be part of the plan. Stranger things have happened, and in the last 12 months alone.
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