Who Will Buy Treasuries?

There are many things that I think about when I wake up in the morning, such as who won the Celtics game last night?  Or did I remember to buy coffee?

On many occasions though, I find myself lying in bed wondering, "who is going to buy US treasuries if the Fed stops?"

It made me feel a little less strange this morning when I found out that the man who runs the world's largest bond fund at PIMCO (over $1 trillion in size) decided to write his monthly newsletter on this exact topic.

He helped us visualize what was taking place in the market with three pie graphs. 

The first (who bought?) shows who owns what percentage of total treasury bonds today.

The second (who's buying now?) shows who is currently buying treasury bonds.

And the third (who will buy?) asks, who is going to replace the 70% of sales in the future that the Fed is purchasing today?

His response:

When applied to the Treasury market it translates to this: The Treasury issues bonds and the Fed buys them. What could be simpler, and who’s to worry? This Sammy Scheme as I’ve described it in recent Outlooks is as foolproof as Ponzi and Madoff until… until… well, until it isn’t. Because like at the end of a typical chain letter, the legitimate corollary question is – Who will buy Treasuries when the Fed doesn’t?

His answer:

I don't know

He then goes on to say that someone will purchase the treasuries, but it will be at a far higher interest rate.  But that is the key point.  If interest rates rise then the cost to finance the debt will grow enormously.

Over 50% of our federal debt needs to be rolled over ever 2 years.  It is the same exact scenario as a short term subprime mortgage with a "teaser" rate.

Our total deficit today stands at $14.195 trillion, $100 million away from the debt ceiling.

80% of our spending currently goes toward entitlements and debt service (interest payments).  This spending (social security, medicare, medicaid) will not be cut.

Entitlement spending is set to explode as the baby boomers retire.  If interest rates rise, the debt service will explode as well.

This is why Bernanke has painted himself into a corner.  There will be no end to Quantitative Easing on June 30, 2011 (which Gross compares to D-Day).  It will be extended.

The gold market, which launched to a new all time record high this afternoon, continues to do what it has over the last 5,000 years: Revalue itself to the underlying paper currency's true value.

And we haven't seen anything yet.