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Liesman: Why Congress Needs Deficit Plan Soon

US Capitol Building with cash
US Capitol Building with cash

Putting together comments made today by Fed Chairman Ben Bernanke and Pimco bond guru Bill Gross offers the following critical suggestion to Congress: It would be a really good idea to put a deficit plan together before the Fed finishes its quantitative easing program in June.

Bernanke, in answer to a question in testimony on the Hill today, said that higher deficits, all things being equal, mean higher interest rates.

This, Bernanke said, would be "bad for the recovery and bad for financial stability." (Watch video of Bernanke's remarks below.)

And, "it would obviously go against efforts of the Fed to keep rates low."

So on the one hand, we have the Fed buying treasuries to keep down interest rates across the economy, while Congress and President Obama are engaged in deficit spending, which if not addressed over some period of time, could push up interest rates.

But the Fed has said it will stop purchasing these bonds in June after taking on, on net, an additional $600 billion of treasuries.

Enter Bill Gross, who buys a boatload of these bonds, warning that the Fed's exit from this market is going to leave a gigantic hole come June. He believes the Treasury will be able to sell its paper, but it will have to offer a higher rate to bring some investors back into the market. (Watch video of Gross' comments to CNBC here.)

Gross suggested 4 percent was not crazy. He added that part of the problem is that the government supply of paper (that is, its deficit) remains high despite the Fed's withdrawal.

The math is something like this: $1.5 trillion of new paper in a year (the deficit) plus $600 billion that the Fed won't be buying, means $2.1 trillion of debt needs to find a home.

All of this leads to a simple conclusion: Congress doesn't have to cut spending dramatically by June. But it would really help the transition to a post-QE world if a deficit reduction plan over several years were in place around then.

This could limit how much interest rates rise as a result of the Fed ending the program.

With a major buyer potentially leaving the market, the factory that produces Treasury paper—Congress and its spending—should think about scaling back production to more properly meet demand.

Failure to do so could make the Fed's exit more painful for the economy.