U.S. Companies Start Dumping Treasuries

Pimco is selling billions of dollars worth of U.S. treasury bonds, in essence showing the government in Washington the red card: It can find no solution to the most pressing economic problems.

It rarely happens that politics and the market have the opportunity to simultaneously show their completely divergent senses of reality, but they were able to pull that trick off earlier this week. The two political parties in Congress squabbled over how to reduce the gigantic deficit, using every trick in the book, but they didn’t succeed in making one millimeter of progress. Meanwhile, the market drew its own conclusions and established the facts.

The Pacific Investment Management Company, better known as Pimco, dumped $28 billion worth of U.S. bonds. That was the total value of these instruments, constituting 12 percent of Pimco’s portfolio. Above all, however, that was the most convincing proof yet of the market’s deep mistrust of the wisdom of U.S. government policy. The world’s largest bond dealers believe they have to get on board as well before they get sucked into the whirlpool along with the United States.

The reasoning behind the major investor’s decision is quite simple: After June, the Federal Reserve will no longer be capable of further grandiose purchases of U.S. debt; there will be an enormous gap in demand for treasuries and Pimco doesn’t see who could replace the Federal Reserve as buyer. It’s true that by June the Fed’s unconventional policy will have resulted in the purchase of $600 billion in bonds. An extension of the program would require the printing of more dollars, something that now appears to be a political impossibility. The U.S. Treasury will be caught in a trap because the Fed currently purchases about 70 percent of U.S. bonds.

Pimco doesn’t want to be the one left to turn out the lights and close the doors. In other words, it doesn’t want to be caught sitting on a mountain of bonds that were bought at high prices and will have to go on the market next summer at lower prices and that will, in all probability, carry lower yields than new bonds being currently issued. The result will be less demand that, in turn, will force Treasury Secretary Tim Geithner to cut bond prices and tempt customers with higher return rates. That’s not only bad for those who bought bonds too prematurely; it’s also bad for the economy because government bond yields set the benchmark for corporate and consumer loan interest rates.

But: The problem would be less severe if a clear political commitment to address the loss of trust were enacted. Both Republican and Democratic politicians, however, seem to think there’s still a lot of time left for tactical games. In mid-week, both parties brought out their respective economic measures for the budget with the full knowledge that neither side could get the requisite 60 votes for passage.

As expected, both versions were voted down: The Republican one because it relied heavily on a radical lawn mower approach, and the Democratic one because it was far too timid and gloomy. That didn’t stop both sides from heartily slapping themselves on the back for the theatrical extravaganza they produced in conference. Now that the theatrics are out of the way, both sides can sit down together and actually look for solutions to the economic crisis. Observers are left rubbing their eyes in disbelief. The politicians might be expected to react this way were it all about petty details and if no other problems existed. But is a trillion dollar deficit really just a minor detail?

Unlike Congress, however, Pimco has actually taken a good look at the budget figures. What’s interesting is the statistic concerning servicing the debt, i.e., the amount of money government must raise just to pay the interest on the debt. According to the Congressional Budget Office (CBO), that sum will rise from the current 8.4 percent of GDP to nearly 10 percent in 2013. Since the CBO calculations don’t include possible interest rate hikes, the deficit could end up actually higher than that if investors can only be enticed to buy government securities with higher yields, i.e., if a growing slice of the budget pie can’t be touched.

But politicians are still unwilling to go after the biggest line items on the budget outlay sheet: Social Security, Medicare/Medicaid and defense spending. Added to debt service, those comprise 75 percent of all outlays. But they’re still nibbling around the edges with savings in education, research and development and investment in infrastructure projects. No budget on earth can be reformed with such measures, and certainly not the budget of a nation so deeply in debt as the United States.