The part that you're not understanding is that the Treasury auctions are purposefully staggered and rigged to make sure that the demand for Treasuries always exist.
Let's take a look at a late June 2011
1-year Treasury Auction when the nation was on the verge of default:
(And yes... these bonds were auctioned with a maturity date well past the scheduled "Default" date)
Even on the verge of default, and huge amounts of debt on our balance sheet, the demand for bonds from the Direct and Indirect bidders was astronomical in this auction (oversubscribed by 4:1). Those Direct and Indirect bidders could have almost covered the entire auction on their own — and it's quite common to see the Direct and Indirect bidders show even more enthusiasm.
But, look at the action from the Primary Dealers...
The Primary Dealer demand was more than
THREE TIMES greater than the amount of debt being auctioned off.
But, how can this be? A nation on the verge of default, and a dire future ahead of it shouldn't be able to auction off its bonds with such high demand, right?
Let's ask the NY Fed how this really works...
Open Market Operations: Gathering Information, Preparing to Act
Staff on the Desk start each workday by gathering information about the market's activities from a number of sources. The Fed's traders discuss with the primary dealers how the day might unfold in the securities market and how the dealers' task of financing their securities positions is progressing. Desk staff also talk with the large banks about their reserve needs and the banks' plans for meeting them and with fed funds brokers about activities in that market.
Reserve forecasters at the New York Fed and at the Board of Governors in Washington, D.C., compile data on bank reserves for the previous day and make projections of factors that could affect reserves for future days. The staff also receives information from the Treasury about its balance at the Federal Reserve and assists the Treasury in managing this balance and Treasury accounts at commercial banks.
Following the discussion with the Treasury, forecasts of reserves are completed. Then, after reviewing all of the information gathered from the various sources, Desk staff develop a plan of action for the day.
That plan is reviewed with interested parties around the system during a conference call held each morning. Conditions in financial markets, including domestic securities and money markets and foreign exchange markets also are reviewed at this time.
Source: http://www.newyorkfed.org/aboutthefed/f ... fed32.html
So, the Treasury calls up the Fed to get a sense about what each auction should look like. The Fed coordinates with the Primary Dealers to monitor reserves, round them up, and then target them — making sure the auction is
always oversubscribed. And they have a few conference calls to make sure everyone is on the same page. It is a highly orchestrated event — nothing more than a way to drain excess reserves, target interest rates and satisfy Congress's old gold-standard-era mandate that all spending must be "funded" by Treasury bonds.
So, what if the Primary Dealers don't want to take part in the auction? Here's the best part... The
Primary Dealers are contractually obligated to take part in these auctions.
Administration of Relationships with Primary Dealers
The primary dealers serve, first and foremost, as trading counterparties of the Federal Reserve Bank of New York (The New York Fed) in its implementation of monetary policy. This role includes the obligations to: (i) participate consistently as counterparty to the New York Fed in its execution of open market operations to carry out U.S. monetary policy pursuant to the direction of the Federal Open Market Committee (FOMC); and (ii) provide the New York Fed’s trading desk with market information and analysis helpful in the formulation and implementation of monetary policy. Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.
See: http://www.newyorkfed.org/markets/pride ... icies.html
If we need to wage a war against another country, we don't pick up the phone to China and ask them to buy our bonds. Not at all. We simply spend the money and we issue the bonds in the highly orchestrated manner described above — draining excess reserves from banks and brokers. If the reserves don't exist, the auction is either delayed until they do exist or the Fed makes a short term loan to the Primary Dealers so that they have the proper reserves (it's not a problem right now since there are too many reserves!)
As long as Americans are willing to save their money, there will always be excess reserves, and therefore, there will always be a demand for US Treasury bonds. And even if the Primary Dealers are in trouble, the Fed
can always help them out.
Now you can see why the so-called "bond vigilantes" don't want to play ball in this game where the house determines all of the rules. That doesn't stop politicians and pundits from scaring you into believing that 'nobody will buy our bonds.' Of course people will buy our bonds. We make sure of it!
And in fact, what we see is that we don't even need China to buy our bonds. So, we can never run out of money in this situation. There will
always be a market for Treasury bonds as long as the Primary Dealers exist and satisfy their obligations in the market.
If China wants to take the US Dollars we give them and return them to the Treasury, so be it. The same thing with households. If we "save" our money, it just ends up back at the Treasury anyhow. We give it back in exchange for compounded interest.
The textbook explanation of how the bond market works only applies to countries that don't control their own currency. For the US (and countries like Japan), it's just a highly coordinated way to influence monetary policy. This is why we aren't, and never will be, Greece.
It's extremely unlikely that the Treasury market could fail. As you can see by the example above, even in the face of a serious default, we have Treasury Bond auctions oversubscribed by more than 4:1.
Nothing I say should be construed as advice or expertise. I am only sharing opinions which may or may not be applicable in any given case.
