- The Washington Times - Tuesday, June 3, 2008

What a difference seven years makes.

When the U.S. Treasury quit issuing its 1-year Treasury bill during the summer of 2001, the federal budget was on its way to a fourth consecutive annual surplus.

When the Treasury resumes its auction of 1-year T-bills Tuesday, the federal budget will have posted six consecutive annual deficits and will be well on its way to a seventh.

In 2001, the Congressional Budget Office had projected budget surpluses totaling $5.6 trillion over the next 10 years. Now, after a six-year string of deficits totaling nearly $1.7 trillion, the Bush administration is projecting budget deficits of $410 billion in 2008 and $407 billion in 2009.

Spending has soared. In 2001, the Bush administration issued its first budget blueprint detailing spending of $1.9 trillion in 2002. In fiscal 2009, federal outlays will exceed $3.1 trillion - reflecting spending increases of more than $1 trillion since 2002.

Contrary to projections, debt, too, has soared. In 2001, Congress passed a budget resolution calling for reducing the publicly held debt from nearly $3.5 trillion to less than $1 trillion over 10 years. Now publicly held debt amounts to nearly $5.3 trillion and is projected to reach $6.1 trillion by 2011. That’s more than $5 trillion higher than forecast in the fiscal 2002 budget resolution.

The Treasury expects to raise $16 billion Tuesday from its auction of 1-year T-bills. It may not come cheap.

Complicating Treasury’s auction is the fact that the Federal Reserve has no plans to purchase any of the securities. Before turmoil erupted throughout the financial markets last year, the Fed could be counted on to increase demand for Treasury bills by purchasing some of them. That’s no longer the case.

“Nobody expected the Fed would stop buying Treasuries,” said Stephen Van Order, a debt strategist at Calvert Asset Management in Bethesda.

In fact, the Fed has now become a net seller of Treasury bills as it tries to alleviate the credit crunch and prevent a meltdown in financial markets.

The Fed created a special mechanism late last year to add liquidity to the financial markets. At the time, commercial banks were reluctant to borrow from the Fed’s discount window because they feared investors would interpret that as a sign of desperation. The new mechanism enabled the Fed to inject liquidity into the banking system without requiring banks to visit the discount window.

With the Fed on the sidelines, “traders don’t have access to a ready source of these [1-year Treasury] securities,” explained David Glocke of the Vanguard Group. That could raise interest rates, adding to the pressure for higher interest rates that is already caused by accelerating inflation and the expectation that the Fed will begin raising rates before the end of the year to combat these pressures.

The U.S. government’s need to increase its borrowing occurs after foreign investors have already raised their ownership of U.S. publicly held debt from 5 percent in 1970 to 22 percent in 1995 to 45 percent last year.

However, the dollar’s value in currency markets has been falling since early 2002. That decline has accelerated recently, causing private foreign investors to cut back their purchases of dollar-denominated securities, said Mr. Van Order.

“Treasury interest rates must rise to sell the securities,” he said.

As interest rates rise, so too will deficits, leading some economists to warn of a vicious cycle that neither the Fed nor Treasury wants to contemplate.

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