Despite soaring budget deficits, investors are still buying U.S. Treasurys. Still, some critics say the government debt isn't nearly as safe as widely assumed.
NEW YORK: When the Federal Reserve announced last week it was buying $300 billion in long-term Treasury notes, the move was viewed as one of the safer bets the central bank has made recently.
After all, the Fed has either bought or announced plans to spend trillions of dollars on troubled mortgages and other types of questionable consumer debt in the past year. At the same time, the Fed has been loaning money to banks and companies that couldn't get funding elsewhere.
So the purchase of AAA-rated Treasurys, the highest credit rating that a bond can have, is probably the least risky thing the Fed can do these days.
Investors agreed: the prices of long-term Treasuries rose after the Fed's announcement, pushing their yields lower. (Bond prices and yields move in opposite directions.) Rates didn't even budge much Friday after the Congressional Budget Office raised its federal budget deficit forecast for this fiscal year.
But is the purchase of Treasurys really as safe an investment as it seems? Some think the U.S. may not be able to hold on to its perfect credit rating indefinitely considering how much money the Fed, Congress, the Fed and the Treasury Department have thrown at the economy in their attempt to lift it from this recession.
"The only reason someone who bought a Treasury can get their money is that the government is able to borrow more money to pay them off," said Peter Schiff, president of brokerage firm Euro Pacific Capital. "It's impossible for us to just keep going deeper and deeper into debt."
0:00 /02:30Fed's trillion dollar gamble Still, that seems to be exactly what the government will be doing. According to credit rating agency Moody's, the amount of U.S. Treasurys held by the public, including foreign governments, is expected to rise to $7.8 billion by the end of the government's fiscal year in September, up from $5.8 trillion a year earlier.
What's more, Moody's predicts that this figure could increase to $9 trillion by September 2010, since the government is likely to take advantage of the current low rates to finance its various bailout efforts. The yield on the 10-Year Treasury is about 2.64%.
But strong demand for Treasurys does little to assure those who think there will be big problems ahead. Critics of federal spending worry that once concerns about the value of the dollar or the government's debt load start to turn, it will turn quickly, sending Treasury prices plunging and longer-term interest rates soaring.
"Anyone who buys a lot of [long-term Treasurys] now might be crazy," said Brian Wesbury, chief economist at First Trust Portfolios. "It's the biggest the bubble in the world."
Higher bond rates can have significant costs for the nation since it would drive up the price that the government has to pay to borrow money. And any increase in how much the government has to spend on interest payments could lead to a reduction in the amount of money available for other government spending.
With the U.S. dependent on foreign investors to buy much of its debt, maintaining overseas confidence in U.S. Treasurys is particularly crucial.
That's why when Chinese Premier Wen Jiabao said earlier this month that he had "some worries" about the safety of the more than $700 billion in U.S. Treasury debt his country holds, it got the attention of bond traders and government officials. Some experts think the Fed's move ‘to start buying Treasurys was at least partly a response to Wen's remarks.