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After having suspended the issuance about three years ago of long dated U.S. inflation-indexed bonds (TIPS), the U.S. Treasury is about to resume issuance by auctioning $11 billion of 20-year TIPS, a larger supply than many dealers had estimated. This is a further signal, along with some recent public comments made by the Treasury, that they will be trying to grow the TIPS market as fast as feasible.

Well, there is little doubt that the Treasury will have some remarkable financing needs for the foreseeable future. The size of this issue is a large amount, especially for the Treasury's first foray in three years. As with all else the government has been doing for a while, it is being presented as "normal business".

I think it is anything but; I think this should be sending a very disturbing signal to the bond market.

Why isn't the bond market asking the question, "Why would the Treasury suddenly be interested in TIPS again?" I can't answer the question for the bond market, I can only tell you what I think the Treasury is thinking.

The risk in a fiat currency is that our trading partners will eventually lose their appetite for it. A fiat currency can be used to pay off debt if that debt is priced in that currency.

Remember, Argentina ran into huge economic problems mainly because the debt that they owed was denominated in dollars, not their own currency. They did not have the ability to print dollars to pay off or restructure their debt; they had to go out and buy dollars to do this. This naturally led to a significant devaluation of their currency against the dollar; the general population lost a great deal of wealth in this process.

The U.S. owes all of its debt in dollars. It merely has to print more dollars to pay off that debt. But if we do this we risk the fact that foreigners will no longer buy incremental future debt. I have written about this scenario before.

In these times of globalization and ever increasing paper debt, it is paramount that this not happen. A declining currency is recognized by domestic markets as inflation: the prices of imported goods for U.S. may be going up for U.S. consumers merely because the dollar is declining. It may be declining just because the government is supplying so much of it. This is what Laurie means by a fiat currency and that the only real currency is gold.

So the Treasury is preparing itself by having more debt issued in TIPS. As the Fed prints dollars into oblivion and the inflation rate (at least the real one and not the reported one) rises, the Treasury must prepare for the possibility that foreigners and domestic buyers of bonds will abandon the straight government bond markets if the dollar declines 30-40%.

This is a real possibility and not "business as usual", at least in my mind.
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