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Obamaflation Update

By Philip Klein on 5.12.09 @ 6:20PM

Back in February, I wrote about how the unprecented level of debt being created to finance government spending would inevitably lead to inflation once demand for U.S. Treasury bonds subsided and the Fed was forced to print money to buy up the debt. With the market choking in debt, we're already starting to see an erosion in demand. In other words, the early stages of that process are underway, and sooner than I would have expected.

Fox Business reports today:

While the stock market is floating at levels way above its early March lows, the Treasury market has been showing signs of weakness as investors, who flocked to the safety of government debt at the height of the credit crisis last fall, have now turned their attentions elsewhere.

This leaves the U.S. Treasury Department, and in essence the U.S. taxpayer, with a prospect of steadily rising costs of borrowing -- especially as the Congressional Budget Office projects a record deficit for the upcoming budget year.

From its mid-December low of around 2.06%, the yield on the benchmark 10-year Treasury bond has risen steadily to 3.18%. Meanwhile, the yield on the less-heavily traded 30-year bond has risen from around 2.5% to 4.19% in Monday trading. Bond yields increase as bond prices, and therefore demand, decrease.

Bond yields have been increasing as investor demand to purchase record amounts of U.S. government debt has been subsiding. Last week, bond prices fell after an auction of $14 billion in 30-years failed to meet expectations.

"These large auctions are starting to stress the system," said Tom DiGaloma, head of fixed-income trading with Guggenheim Partners. "There have been too many auctions held too frequently, and the size of the auctions is growing too fast for the market to handle."

While supply and demand always work in tandem, traders and investors said the main issue in the bond market right now is too much supply. The U.S. government has been issuing debt at a quickening pace in recent months, in part to pay for increases in government spending like $787 billion economic stimulus package, but also to take advantage of lower-than-usual bond yields.

The Fed has already been forced to purchase government bonds to prop up Treasury prices. Add the looming entiltement crisis (now looming closer) and trillions of new spending on Obama administration intiatives such as health care, and the inflationary pressure will only become more severe.

And remember, the Fed won't want to slow down the economy by raising interest rates, and even if they were willing to, they don't have any options if the market simply doesn't have an appetite for more debt. The only option is to print, print, print. And so the inflationary spiral continues. Unless, of course, we stop spending trillions of dollars that we don't have.