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Zeno of Elea
The foreign appetite for US debt will be tested, as will the pocketbooks of American taxpayers.
Zeno of Elea was a Greek philosopher ca. 450 BC and a contemporary of Aristotle. A member of the Eleatic School, which employed reductio ad absurdum, debate by which arguments are proven incorrect by showing their premises lead to contradictions, Zeno has been credited by some with laying the foundation for modern logic. Zeno created a set of paradoxes, or thought problems, to challenge philosophers and mathematicians of the day. It was not until the onset of the calculus many centuries later that most were rigorously ‘proofed’ as refuted. One of these, the dichotomy paradox was so refuted…that is, until this week in the halls of the U.S. Congress.
The dichotomy paradox takes number theory to its absurd conclusion: simply, there is an infinite amount of numbers between 1 and 2. Therefore, in theory, take your hand one foot away from the wall, close the distance by half, then half again, and so forth -- and theoretically, your hand will never touch the wall. But the calculus methods of handling infinities (and you hand feeling the wall) are proof enough to show this is a purely philosophical argument: There is a finite space, despite the description with an infinite number series.
So, I was surprised to see this week that the U.S. Treasury Secretary Henry Paulson had created the infinite from the finite. Last I heard regarding the Fannie and Freddie saga was for the Treasury to buy $2.5 billion of equity in the corporations, if needed. But today, that number became "undefined" -- or, if you will, infinite, as Congress hammered out details.
The bill provides $300 billion to refinance and insure loans through the government-sponsored enterprises (GSEs). We have been told that only a fraction of that sum will actually be needed, but exactly who out there knows what the final number will be. To say nothing of the more than 1 trillion dollars worth of insured mortgages, the GSEs now are in possession of nearly $7 billion worth of Real Estate Owned (REO), and with foreclosures running at better than 4,000 a day across the U.S., that number is climbing rapidly. Also, with the collapse of the mortgage finance markets, the GSEs are now responsible for 80% of loans originated in 2008, and that number will grow. The amount of money needed to support this system during a period of financial stress and decreasing real estate values is at least staggering, and at most understated.
Already we are seeing record levels of debt sales, and this amount will increase dramatically as the cost of all this support and stimulus comes due. The foreign appetite for US debt will be tested, as will the pocketbooks of American taxpayers. Unless I am missing something, there is no way this type of deficit spending can be positive for U.S. Treasury bond yields over the long run.
History notes that when Zeno attempted to, but failed, to kill the tyrant Demylus, “with his own teeth bit off his tongue, he spit in the tyrant’s face.” I know how he felt.
This story originally appeared on the Daily Forecast page for the U.S. 30-year Treasury Bonds, inside Bill Fox's Interest Rates Specialty Service.
Bill Fox is EWI's Senior Bonds Analyst. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders.
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