Into The Grey Zone The future is always a grey zone, never black and white.

So the bond auction Wednesday went very poorly and the Tuesday auction was lackluster as well. I'm waiting to see what the Thursday auction does but expectations are low already. Prices are falling, causing interest rates to rise. Our foreign creditors are sending a message to Washington, DC, assuming there is anyone in Washington smart enough to actually read it. If not, China may do something even more drastic, not to permanently hurt us, but to warn us, to force us onto a fiscal track that would ensure that China gets paid back.

If the United States today had to balance its federal budget, we would have somewhere between $1.2 and $1.5 trillion dollars in tax revenue. The current budget calls for $3.6 trillion in spending. This is like a guy who makes $40,000 spending $100,000 annually. That's not a good prescription. It also means that small budget cuts won't help. This year's deficit is between two thirds and three quarters of all spending so that's how much spending has to be cut. How can you do that and still have a federal government? You totally shut down Social Security, Medicare, Medicaid, and all welfare programs. Then you close 990 of the 1000+ American military bases overseas, bring home the troops, then cut the military in half. Then and only then is the budget close to being balanced. And what is the cost? Approximately a 30%-40% drop in GDP, unemployment nearing 50%, and very probably the end of the United States as we know it.

So China is not going to make us balance our budget overnight. The US would fold and China would never be repaid. But China is going to force our hand, slowly but steadily towards tighter budgets. And those budget changes will only come via a slow steady erosion of government benefits. That means that the US government can't hyperinflate, if it wants to remain a global player. Hyperinflating or defaulting on our debt, effectively would remove the United States from the center of the global stage and those in power don't want that. So what is the alternative? A deflationary depression, forcing slow but steady spending cuts and slow but steady loss of benefits. And along the way, if they rig the game right, a deflationary depression also allows those in power to grab real assets for a fraction of their former values. And they think that you'll just accept it if each day is only a little bit worse than the day before. So far they've been right too. People generally have accepted it. Of course there are people not accepting it but that's hardly something to discuss publicly, except to tease the watchdogs that may be listening.

By the way, Wednesday's bid-to-cover ratio was the worst that it has been since September 2008. We all remember what happened in September 2008 after those poor bond auctions, right? Karl Denninger accurately says US 5yr Bond Auction Effectively FAILS. Read his post for more details. I would remind those few who still bother to read here that Ilargi and Stoneleigh over at The Automatic Earth called this rally back in January when we were still declining to the March lows. And they have been predicting a reversal of this rally, probably this autumn. Well it's the end of July now, folks, and September isn't that far away.

Keep your pantry stocked and your powder dry. You may need it.

Edit: Looking back it's pretty obvious what happened last week - the bond market was trying to send Washington a message. Auction participation was low on Monday and Tuesday, and catastrophically low on Wednesday. Wednesday would have been a failed auction except for the rigged primary dealer network who had to eat the auction. After sending that message, China and others rejoined the market on Thursday sending bond rates down significantly. In short, our creditors flexed their muscles to show us what they can do. If Obama and company were not listening, there may be harsher lessons waiting in the wings.

Edit 2: Looks like my guess about last week was wrong. BLATANT Monetization Uncovered What happened on Thursday was that the Fed conspired with the primary dealers to buy up the auction, then the Fed bought it back this week. In other words, blatant printing. Not good. Not good at all.