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However, it will not be possible for the USD to strengthen past the moment that auctions of US Treasuries start to go badly, as buyers either refuse to buy or start to demand much higher rates (lower prices) for those bonds. When that point is hit (or anticipated) the USD will be unable to strengthen and the full effects of the current reflationary efforts will rush to center stage, as our purchasing power heads downward again. So in a way, the inflation-deflation debate here in the US now moves directly to the fate of the US Treasury bond market.
On the matter of anticipation: investors in the US Treasury bond market can roughly be divided into two groups. The first are price insensitive buyers like foreign governments who recycle dollars, and large pension funds who buy because of investment mandates. The second are discretionary buyers, like mutual funds, hedge funds, individuals. The second group will very likely have started exiting the US Treasury bond market before there are actual problems with rolling over the maturing debt. This could begin at any time. And there are hints the reactions may have already begun.
I have watched the growth of the public debt for years. It was only 18 months ago that I wondered when the debt limit ceiling would be raised beyond 10 Trillion. As you can see in the above graphic, we have exploded past that level now. With more to come.
My view is that because current events in equity and credit markets are so dramatic, the market has not yet paid attention to the coming boundary, of debt-ology. However, I expect participants to direct their thinking this way quickly, once the intensity of the crisis lessens. I see two areas, where markets will inevitably focus.
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