Who Is Going to Buy Treasurys Now that QE2 Is Ending?

By DoctoRx

The dog that is not barking in the financial media may be the lack of discussion of the title question.

Presumably, Chairman Bernanke and Treasury Sec’y Geithner have had more than a chat or two about how the latter man is going to keep the Treasury in business once the former ends his purchase of vast quantities of Treasury bonds, popularly called QE2, at the end of this month.

It has been assumed for some time in many circles that the Fed will be able to monetize some additional Treasurys by taking the principal and interest from its holdings of mortgage-backed securities and buying Treasurys with them. That and similar measures will allow the Fed to finance a modest portion of the government’s vast need for financing of new debt. This need is truly vast. The amount far exceeds the stated deficit. It also includes, annually, hundreds of billions of dollars of newly-created student loans and new Fannie/Freddie-related cash outlays. 

It is possible to conceive of what I think of as protectorates such as Kuwait and some of its neighbors being reminded that their regimes could go the way of Mr. Mubarak’s if the US so wished, and so they could be “asked” to buy more Treasurys. But that might be “it”. China may not interested in more US debt and Japan cannot do much more than keep its holdings roughly static.

The thought that I would like to toss out to the readership is that it just may be suggested to US-based lending institutions that they could do worse than invest in short- and intermediate-term Treasury securities. So-called “excess reserves” of these institutions could cover the expected deficit for quite some time. Not only are they large, but they are growing rapidly. Currently the Fed is paying interest of 0.25% (or so) on them. Here is a chart of excess reserves from the St. Louis Fed:

As of May 2011, the total excess reserves of depository institutions was above $1.5 trillion. This was up by nearly $400 billion in merely 4 months.

One wonders where all the new excess funds are coming from. After all, the government takes the money it borrows, including new money “printed” up by the Fed in QE2, and spends it. It sends checks to Medicare recipients, for Medicaid, to Social Security recipients, to soldiers, to armament manufacturers, etc. 

In any case, taking the quantity at face value, note that historically this value was . . . around zero.

If the economy is decelerating once again, so that demand for loans is still not going to grow fast if at all, why does it not make sense to the authorities to save the Fed the expense of paying interest on these excess reserves, let the Fed keep its word for a while regarding any QE3, and have a partly captive financial system fund the deficit out of the excess reserves now on deposit with the Fed?

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