Will sales of T-bills continue to flourish?

WASHINGTON — The federal government is being forced to greatly expand its sales of Treasury bills, notes and bonds to cover a deficit that is projected to soar this year to eye-popping levels. So far all that new debt had been sold at low interest rates as investors have preferred the safety of Treasury securities in uncertain times. But what would happen if that changed?

If China and other foreign investors suddenly stopped buying U.S. debt, the cost of borrowing for consumers and businesses could rise and the value of the dollar could fall, raising the threat of inflation.

Chances of that outcome still remain remote, but analysts are worried about what might happen if Congress and the Obama administration can't start to curb deficit spending soon.

Here are questions and answers examining the links between the government's borrowing needs and the economy.

Q: What is happening to the government's need to borrow money to finance its operations?

A: The government's borrowing needs are ballooning, a reflection of the billions of dollars being spent to lift the economy out of a deep recession and deal with the worst financial crisis in seven decades. The Obama administration estimates that the deficit for the current budget year, which ends on Sept. 30, will total an all-time high of $1.84 trillion. That would be four times the size of the current record, last year's $454.8 billion deficit. As a share of the overall economy, the deficit this year would be the highest since 1945 when the government was borrowing heavily to win World War II.

Q: How are the current deficits being financed?

A: The government is expanding the amounts of Treasury securities it is selling on everything from the three-month and six-month bills it auctions on a weekly basis to 30-year bonds. The 30-year bonds are now being auctioned monthly, up from four times a year.

Q: How are bond investors reacting?

A: So far, the debt sales have gone smoothly with interest rates remaining at historic lows. The government's surging borrowing needs are coming at a time when investors have staged a flight to the safety of U.S. Treasurys in response to the severe financial market turmoil.

The rates on three-month and six-month Treasury bills have been trading well-below 1 percent so far this year, including at the most recent auction on Tuesday. At one point last fall when the market panic was at its height, the yield on the four-week Treasury bill dropped to a record low of zero, meaning investors were willing to accept no return at all for loaning the government money.

Q: If these rates are remaining low, why is there concern?

A: While three-month and six-month bills are heavily influenced by the Federal Reserve, which has driven a key short-term rate to a record low in an effort to jump-start the economy, longer-term rates are more influenced by market forces. There rates have been rising recently.

Rates for 10-year Treasury securities last week rose to above 3.4 percent on Friday, the highest level since November, and headed even higher on Monday. The 10-year Treasury is the benchmark rate for many mortgage loans. The worry is that rising rates in this area could drive mortgage rates higher and also increase the cost of borrowing for businesses. That development could short-circuit the nation's efforts to emerge from a deep recession and the worst housing crisis in decades.

Q: How likely is such an outcome?

A: Many economists believe that the Federal Reserve, which is already spending billions of dollars to drive mortgage rates lower and assist in a housing recovery, will simply step up its purchases of mortgage-backed securities. However, there are other factors at play as well which could overwhelm the Fed's efforts.

Q: What are those factors?

A: Foreign investors hold a major chunk of the federal government's debt — about 47 percent of the roughly $7 trillion that is held by the public. The rest of the $11.3 trillion total national debt is held in government trust funds such as the Social Security trust fund.

China last September surpassed Japan as the largest foreign holder of Treasury securities. The worry is that at some point China and other foreign investors might decide they want to hold less in Treasury securities, a switch that would mean falling demand at Treasury debt auctions and rising interest rates.

Q: Wouldn't rising interest rates slow and possibly derail any recovery?

A: Yes. The concern is that a plunging dollar could leave the country caught between weak economic growth and rising inflation, a situation that was dubbed "stagflation" when it last occurred in the United States during the oil price shocks of the 1970s.

Q: How big a threat is the risk of rising interest rates and a falling dollar stemming from the government's huge financing needs?

A: Economists believe that the risk is low, at least in the short term, because the economy is so weak. The weak economy means that businesses do not have as great a need to borrow from the same investment pool as the federal government.