Post-Apocalyptic Zombie Finance

That’s the title of this morning’s “Spengler” essay at Asia Times. I’ve never seen anything quite like this, except, of course, in Japan during the 1990s—but not on a global scale, and not with the world’s main reserve currency. The global banking system is financing the US deficit via the carry trade (borrowing cheap money from central banks directly or indirectly and lending it back to the US government). It’s not the Asian central banks—it’s the banks themselves. We need a new word in the English language, something like the present word “bubble” but without the connotation of permanence and stability.

Here are the numbers:

Between November and January, the last month for which Treasury data are available, foreign private investors (overwhelmingly banks) bought $60 billion a month of Treasury notes and bonds - an annual rate of $720 billion, or about half the total annualized borrowing requirement of the US government.
Note that the central banks of the world have not increased their holdings of US government securities to a significant extent. Their net purchases are running at a modest $20 billion a month, or an annual rate of $240 billion.

This sort of zombie equilibrium persisted for two decades in Japan’s moribund economy; in theory, the US Treasury and the financial system could keep it going indefinitely. But there are a hundred ways in which this arrangement could go wrong.

Weaker governments like Greece and Spain, or even the United Kingdom, could snap the chain. A shift out of US dollars in response to monetary inflation could force the Federal Reserve to raise interest rates. An attempt by investors to ease out of thecarry trade could provoke a stampede for the exits. Japan has managed to keep its bubble going for 20 years. But Japan did so on the strength of its domestic banking system under the supervision of the Bank of Japan; the United States depends on the reserve status of the dollar, which makes less and less sense when the Treasury is flooding the world with US liabilities.

We have never seen anything quite like this before, and one hesitates to make forecasts about an arrangement so absurd and unstable that the list of potential break-points is endless. Now that the whole world is buying US government debt on borrowed money, it makes no sense to own it. It will end badly - but it is too early to specify just how and when.