Montreal, Canada

There’s got to be something wrong with this story.

Last week, the U.S. Treasury recorded its strongest demand for ten-year notes since the 1980s, raising $21 billion dollars. This occurred despite government data reporting a record monthly budget deficit in February. Year-to-date in 2010, the United States is running a record $651.6 billion dollar budget deficit.

At a time when many governments in the industrialized West are issuing record amounts of debt to finance post-2008 spending packages, the United States is still paying relatively low rates. Incredible that ten-year rates are at 3.7% for a country spending like mad.

Despite the massive amount of financing required to sustain its deficits this year, Treasury hasn’t paid a premium to attract funding. The ten-year auction last Thursday drew $72.5 billion dollars in bids or 3.45 times more than the offer. That followed a successful auction of three-year T-bonds a day earlier that raised $40 billion dollars.

The United States, which logged a record budget deficit of approximately $1.4 trillion dollars in 2009, is projected to record $1.2 trillion dollars deficit in fiscal 2010. Since 2007 the government has literally printed more money from an electronic keyboard at the Fed than at any other time in U.S. financial history. Inflation, though struggling to recover since mid-2008, will find a home once banks start lending again or worse, if Treasury’s fail to attract sufficient bids resulting in a new round of Fed quantitative easing

Still, just how long will the United States continue to attract monster-sized funding in the absence of rising interest rate premiums to service this debt is hard to say; but if events in Greece and Dubai over the last four months are any indication, Treasury will have to pay higher rates at some point in the near future. No nation in the midst of a bull market in bond issuance or supply can escape higher interest rate costs indefinitely. Long-term rates must rise eventually.

The U.S. has suffered several weaker than expected auctions over the last 12 months but no single auction has completely failed. But in Europe, several euro-zone countries have postponed, reduced or scrapped government bond auctions since late 2008, including Germany.

Thus far, according to Treasury, foreign central banks and domestic institutions have soaked-up the tidal wave of Treasury issuance. Yet for some central banks, like China, the long-term accumulation phase of Treasury paper has begun to unwind since the mid-2000s as she reduces dollar-based reserves in exchange for EUR, other foreign currencies and gold. In January, China reported a much smaller tranche of Treasury purchases -- surprising many in the market.

It’s outright ridiculous for any country – even a reserve currency – to expect international funding to continue forever in the absence of spending cuts and out-of-control deficits. The European Central Bank (ECB) knows this. Canada understands this. But the United States keeps pushing its debt ceiling to the limit and bringing her closer to a funding crisis in the future. And whatever the rest of the world doesn’t purchase, the Fed cannot be expected to mop-up excess Treasury supply without inviting serious inflationary consequences down the road.

So far, the United States is enjoying brisk demand at her auctions. But for how long?