David Stockman: Vicious Sell-Off In Bond Market Could Force Action on Budget Deficit, Debt

10-year Treasury Yield
David Stockman, former budget director under President Reagan, appeared on Bloomberg TV on May 23 and warned that a major dislocation in the bond market could force congressional action on the $1.5 trillion budget deficit and national debt ($6 billion a day borrowing spree). The catalyst could be the end of QE2, when the Fed stops buying Treasuries. He said both parties are advocating a "de-facto" default by not addressing the issue (cut spending and increase tax revenues). Watch the Bloomberg video after the jump. I threw up a chart of the 10-year treasury yield (via St. Louis Fed). When the 10-year yield breaks through that downtrend line from 1982, watch out for bond vigilantes. Here are a few quotes from the transcript.

On when Washington will get to the point of discussing raising taxes:
"I think [Washington will discuss raising taxes] only when we get a major, thundering conflagration in the bond market."

"For the last 10 years, Congress has been lulled to sleep by the central banks that keep buying all the debt and therefore holding down the real cost of interest on the middle and long term debt that we are issuing every day.

"And frankly, bond fund managers who somehow think that the tooth fairy is going to arrive and fix this problem, when it's clear that is not going to happen, and that we have sovereign risk on the debt of the United States, just as clearly as the world is now discovering there are sovereign risks in the European debt issues and so forth."

On whether there will be a 9/11-style crisis in the economy:
"That kind of crisis would be a vicious sell-off in the global bond market. That could come sooner than people think, because the Fed is getting out of the market with QE2 ending.”

"For the last six months, the Fed has bought nearly 100% of this $6 billion a day that's been issued. Once they are out of the market, where is the new bid, where is the new demand going to come from? The Chinese are getting out of the market because finally they are having to deal with the rip-roaring inflation they have had. The people's printing press of China will not be buying as much U.S. debt because of its own internal problems.”

"When we get to real investors, what are some of the real investors saying today? PIMCO is short the bond, they're selling, they're not buying.

"When we get into a two-way market when real investors began to look at real risk, begin to look at the gong show in Washington and the magnitude of the gap that we are borrowing, I think we're going to get a re-rating of sovereign risk. We're going to get a huge dislocation in the global bond market, and then maybe the wake-up call will finally come."

Source: http://www.bloomberg.com/video/70070512/

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